June 19, 2006	Monday	Jumadi-ul-Awwal 22, 1427

THE Federal Budget 06-07 has been interpreted in many ways but, in essence, it was an admission (evasive and disguised though) of the serious gaps that have developed in the economy, and need plugging urgently. This is the outcome of relying on the distributive justice of a rapidly deregulated private sector.

The campaign to get re-elected the party-in-power always begins with extending relief to the under-privileged in the guise of the ‘benevolence’ of the government. That seems to be happening in Pakistan.

The size of the relief package revealed the parameters of the inequalities that were creeping into the economy over the years in spite of government denials. The fact that dearness allowance (15 per cent) doled out to government servants is twice the officially admitted level of CPI (8 per cent), is one disguised admission of this reality.

Like its predecessors, this government too failed to institutionalise strategies for responding to emerging negative trends and eliminating the need for dole outs that symbolise belated rescue for prolonged managerial failure. The delay, with which the government responded to skyrocketing prices of basic commodities, betrayed the absence of a strategy for responding quickly to developing trends in the commodity markets.

Loud claims about strategic forward purchases commodities (likely to be in short supply due to a bad harvest) seem hollow, and sceptics cannot be faulted if they allege unholy alliances-for-mutual-benefit between state functionaries and the business community. The token fines levied on sugar manufacturers reinforce this suspicion.

The size of PSDP is commendable but a question mark hangs over its utilisation, to make the difference it aims at. If recent government record of accomplishment is anything to go by, allocated funds may not be utilised fully, yet again. Unless there has been a radical improvement in the capacity (invisible, so far) of the concerned agencies to utilize funds purposefully, PSDP figure may only boost the re-election prospects of the party in power, nothing more.

Making worthwhile use of the huge sum of Rs415 billion is a challenge because availability of huge funds (how certain is their availability, anyway?) carries the danger of their waste. To ensure that this doesn’t happen, the government must put in place a powerful bi-partisan overseeing mechanism that is compatible with the allocation not just in size and networking but, more importantly, in supervisory capacity.

The budget did not dwell on this aspect. The government obviously didn’t realise that in a fiscal year preceding general elections, scandals involving utilization of PSDP funds could entail damaging consequences for the party in power. It is not too late in the day to think through this critical issue and come up with a plausible and credible mechanism because it is crucial for convincing foreign lenders who would be asked to provide over half (Rs239 billion) the PSDP funds.

During the last four years, annual expansion in bank credit averaged Rs300 billion. Bulk of this growth resulted from lax lending policies, especially in consumer finance – a fact also frowned at by the World Bank in its recent advice to the government.

In 06-07, credit expansion is in for a slowdown as shrinking savings (due consumer finance overhang), rising lending rates (due lower savings), and slowing global demand begin to assert their combined influence.

In this backdrop, budgetary targets will be achievable only if the economy continues to perform and earn enough to generate the budgeted tax revenues. To ensure that the economy does not contract significantly, the banking sector must meet the borrowing needs of business and industry, albeit at a lower level compared to the last four years. It implies credit availability to the private sector between Rs250 billion to Rs280 billion.

The budget envisages borrowing Rs140 billion from the banking sector; the figure is based on the assumption that conditions will remain as good or bad, as at present. Given the developing global economic slowdown, even without a major economic shock, banking sector will not be able to accommodate enhanced public sector borrowing, more so, if it is for half the overall growth (a maximum of Rs280 billion) in bank credit.

Government expenditure estimates always defy containment within pre-set limits. During 05-06, most federal ministries exceeded their targets for non-development expenditure, with ministry of agriculture and PM secretariat overshooting the target by 100 per cent or more. Should the economic scenario change for the worse necessitating further subsidies, public sector borrowing could exceed the target substantially.

In that case, public sector borrowing could swallow a huge chunk of bank credit crowding out the private sector. Such a scenario will jack up interest rates, push up inflation beyond its current suspect level of eight per cent, and defy accumulation of projected tax revenues. Such a scenario will start a vicious circle that may be hard to break. Monetary management (or was it demand management?) by SBP’s Dr Yaqub during the 1990s is a reminder of such a possibility.

That is not all; in spite of continued criticism of over-liberal imports, the budget does not envisage containing imports, especially of sedan cars and electronic consumer goods. Instead of maintaining import duties at their current levels to sustain revenue contribution by import duties, the budget has opted for imposing taxes that will weaken the incentive for setting up industries for import substitution.

There is no justification for liberalising import of sedan cars, old or new, in an environment of killing fuel prices, and encouraging banks to waste public savings on extending credit to already overstretched consumers. The right option was to encourage auto assemblers and the vendor industry to produce quality cars (unlike what they do now) for export, and invest the proceeds in building overhead rail systems in all the big industrial cities.

Balance of Payments(BoP) deficit in the first eleven months of 05-06 has already reached $10.6 billion. A stable rupee has been the proud achievement of the government but these deficit trends will force de-valuation of the rupee. In that case, containing escalation of the rupee interest rate and inflation will be impossible.

The government needs to re-think the strategy; it cannot liberalise imports of marginally productive goods. Nor should it allow profit-hungry banks to over-allocate resources to consumer finance. De-regulated banks appear to be bartering away prudence for profit. Exhaustion of exchange reserves, though for different reasons this time, could push the economy back to the state it was in after May 28, 1999.

Lowering the BoP and current account deficits is essential, and it will require selectivity in imports dictated purely by economic and real returns. Incentives should be reserved for sectors that expand the capacity for import substitution; ironically for an agrarian economy like Pakistan, agriculture too is now in this category. Fortunately, to an extent, the budget has recognised the needs of this sector.

Unless we begin by making these commitments, it will not be possible to achieve any of the budgetary targets, and the promising picture painted by the budget could quickly fade away. Already, economic analysts seem worried about the possibility of fiscal slippages that could exacerbate vulnerabilities stemming from Pakistan’s high overall debt, debt-servicing burden, and BoP and current account deficits.

The huge profits they made in recent years, players in the private sector can now challenge the government at every step, be it pricing, regulation, taxation, or good governance. The government either must play by their rules or they (just look at the stock exchanges) won’t play. The government needs to re-assess its policy of going overboard in appeasing the private sector, which created rivals that it now finds hard to fight.