Fiscal blowout in the making

Updated February 21, 2019

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The writer is a member of staff.
The writer is a member of staff.

THE numbers are getting a little crazy now. Data released by the finance ministry on the state of revenues and expenditures for the first half of the fiscal year show that the budget deficit is spiralling on faster than ever.

Here is what the data shows. The deficit has grown by 29 per cent in the first six months of the fiscal year, a much faster rate of growth than in recent years. Revenue growth was identified by the State Bank as one of the prime drivers of the deficit in quarter one, when the pace of revenue collection grew by a paltry 7.5pc year on year. But in the second quarter revenue collection actually fell by 9.9pc, coming in at Rs2.33 trillion from Rs2.39tr last year. This is disturbing, to say the least.

Commenting on why revenues were slow in the first quarter, the State Bank attributed it to reduction in the rate of sales tax on major petroleum products and reduction in corporate and income tax rates announced in the budget by the outgoing government, as well as a sharp fall in development spending and an overall slowdown in the economy.

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Since then, all these factors have been aggravated. The projected growth rate for the remainder of the fiscal year has been downgraded, the sales tax reduction on petroleum products has not been increased, development spending has been slashed further (it was down 42.5pc in the first quarter, and another 32.5pc in the second quarter). So it is hard to see where the driver for revenues in the remainder of the fiscal year is. It was supposed to be the ‘mini budget’ announced by the government earlier this year, but given they have only just begun debating that finance bill more than a month after it was tabled, and that it contains no significant revenue measures (only further tax breaks), it is hard to imagine how it will spur revenue growth till year end.

Compared to the first half period last year, this year we have what is known as a primary deficit.

On expenditures the fastest growing item was defence, followed closely by debt service. The latter grew by 13.9pc in quarter one, which jumped to 20.8pc by second quarter (all figures are year on year). Defence grew at 20.1pc in first quarter, and climbed to 23pc in second quarter. In the budget presented by the outgoing government last April, all expenditures were frozen except for defence which was hiked by 18pc. The actual spending on this head is coming in even higher, and the pace is accelerating from first quarter to second.

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This means compared to the first half period last year, this year we have what is known as a primary deficit. A quick (though simplified) way to calculate the primary deficit would be to take total expenditures, subtract debt service payments from it and subtract this number from total revenue collection. If the number you get is negative, the primary balance is in deficit, which means you are now borrowing to pay for interest on loans. Last year, the primary balance was negative (by about Rs35bn as per this calculation, which admittedly is a back-of-the-envelope way of going about it).

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This year’s numbers give us a primary deficit of around Rs153bn in the first half of the fiscal year. In order to rectify this, the government has to immediately cut current expenditures outside of debt service by this amount, or raise taxes by an equivalent amount while arresting further increase in all current expenditures.

This will be a challenge for a couple of reasons, one being that going forward the government is rolling over domestic debt onto very high interest rates. On Wednesday a Pakistan Investment Bond (PIB) auction fetched a decent response from the market after a long time. But compare the yields and you’ll see what is happening. From earlier in 2018, the yields have risen from between 7pc and 8pc to between 12pc and 13pc today. This means as the rollovers continue, domestic debt service payments will rise even more, unless the government wants to continue printing money.

The other reason why bringing the primary balance under control will be difficult is because this government appears to be in no position to tell the military that defence spending needs to be restra­i­ned, especially not in the current environment.

This leaves revenue generation as the main source of stabilising the primary balance, particularly tax collection. But on that front the government seems more interested in pleasing the business community in the hopes that such acts of kindness will bring forth higher export earnings and propel growth in the immediate term. It is walking towards disappointment on both these expectations. The business community is very skilled at presenting its case, and equally skilled at explaining why its end of the bargain failed to materialise.

So far the picture that is shaping up does not look very good. The external sector has started seeing some improvement, but mostly because imports have fallen in significant measure due to a continuing fall in oil prices. Exports are not picking up as fast as they should considering the massive devaluations we have seen recently. This is an untenable situation, and should there be a revival in growth, as the government is eagerly hoping for, it will easily reverse this trend.

One ends up sounding like a broken record when commenting on the direction of the economy in this country. It would be lovely to have the opportunity to point to all the wonderful, positive work that is being done in many places. But that would be like the grin on a dog’s face, given the fact that our very own prime minister has sat with the managing director of the IMF recently and asked for financial assistance, and promised “deep structural reform” in return.

Countries whose prospects are brightening, that have cleared the storms of uncertainty, are usually not found on the doorstep of the IMF, unless they are on the way out.

The writer is a member of staff.

khurram.husain@gmail.com

Twitter: @khurramhusain

Published in Dawn, February 21st, 2019