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Provinces drive deficit out of hand

Updated September 11, 2017

The worst fears of the critics of the 2010 devolution sadly appear to be coming true. Financially devolved and powerful provinces have started to drive the country’s fiscal deficit out of hand.

The provinces had promised to take effective steps to help raise the tax-to-GDP ratio to 15 per cent in five years under the 7th National Finance Commission (NFC) award. However, overwhelmed by the pre-election urge, all the four provinces have opened their kitties to constituency politics with populist dole-outs, showing no signs of fiscal responsibility.

The 7th NFC award and the 18th constitutional amendment respectively transferred increased provincial share in the country’s total revenue by a big margin and empowered the provinces to administer additional responsibilities including health, education, etc.

The PML-N, although part of this devolution, has since been trying to rebalance the arrangement.

Finance Minister Ishaq Dar has already demanded at the level of the NFC, the Council of Common Interests (CCI) and even the National Assembly that the provinces should set aside up to seven per cent of all divisible resources at Islamabad’s disposal to meet any additional cost of security, development of tribal areas and special areas like Azad Kashmir and Gilgit-Baltistan.

A summary of Consolidated Federal and Provincial Budgetary Operations for 2016-17 released by the Ministry of Finance last week revealed that Pakistan’s fiscal deficit had accumulated to 5.8pc of gross domestic product (GDP) against a budgeted limit of 3.8pc.

In terms of GDP, this was the highest in four years of the PML-N government and in absolute terms it reached Rs1.864 trillion — the highest in 70 years.

Two per cent of GDP works out at about Rs635 billion and almost 80pc of that appeared to have been contributed by the four provinces. Roughly, 1.5 per cent of the deficit was contributed by the four provinces and around half a per cent by the federal government.

Overwhelmed by the pre-election urge, all four provinces have opened their kitties to constituency politics with populist dole-outs, showing no signs of fiscal responsibility

The budget deficit ending June 30, 2017 amounted to Rs1.864tr against a budgeted limit of Rs1.276tr, showing a net Rs588bn worth of slippage.

Major contribution to the country’s historic fiscal deficit appeared to have come from the provinces that were required to provide a cash surplus of about Rs339bn during the last financial year.

This was part of an agreement among the finance secretaries of the provinces and the federal government as part of pre-budget consultations. Instead of surplus, the provinces together offered another deficit of more than Rs163bn, making a net slippage of around Rs502bn.

The highest deficit was booked by Khyber Pakhtunkhwa at Rs75bn, followed by Sindh with Rs61.5bn. The Balochistan government also contributed its bit by overspending Rs22bn while the Punjab government posted a Rs4.95bn deficit.

This was also evident from a surge in provincial expenditures that amounted to 5.4pc of GDP in 2016-17 against 4.8pc of GDP four years ago.

The armed forces also exceeded their revised expenditure ceiling by Rs47bn through spending more than Rs888bn during fiscal year 2016-17 against Rs841bn sanctioned by parliament.

The defence expenditure amounted to 2.8pc of GDP during 2016-17 relatively higher as compared to 2.6pc of GDP in 2015-16. In absolute terms, the federal government posted Rs1.778tr deficit at the end of fiscal year ending June 30, against a budgeted limit of Rs1.615tr.

The provincial governments have been resisting contributing to any contingency fund proposed by the centre for absorbing unexpected fiscal shocks of national importance, like security emergencies and liabilities of the power sector. The result has been no progress on a consensus on the 9th NFC award and extension of 7th award practically for three years.

Ironically, this award did not include a strategy to counter unexpected fiscal shocks even though it included a possibility of federal government assisting the provinces in times of unforeseen calamities.

Some critics of the 7th NFC award had pointed out that it was largely silent about sharing the burden of financing joint responsibilities falling under the jurisdiction of the CCI like public debt and electricity debt.

The arrangement was already leading to higher-than-budgeted fiscal deficits in the country, slower structural reforms and limited incentives for enhanced revenue collection.

In fact, both the federal and provincial governments had miserably failed to achieve targeted revenue growth committed in the 7th NFC. Sadly, neither the federal government, nor any of the provinces could follow yearly targets to increase tax-to-GDP ratios.

Under Article 9 of the NFC, approved in 2009, the federal and provincial governments were required to streamline their tax collection systems, reduce leakages and increase tax-to-GDP ratio to 15pc. Provinces were also required to initiate steps to effectively tax the agriculture and real estate sectors.

This did not materialise. Together, the federal and provincial federal governments could increase tax-to-GDP ratio by a paltry 0.3pc to 10.4pc by terminal year of 2014-15 — far behind NFC target of 15pc. The overall tax-to-GDP ratio had stayed below the starting point of 10.7pc throughout the five years.

The cumulative tax-to-GDP ratio of the four provinces also stood at 0.7pc of GDP in 2013-14 and 0.8pc by the end of 2014-15. This too was far behind the NFC target of 1.15pc increase by 2014-15.

Published in Dawn, The Business and Finance Weekly, September 11th, 2017