Fiscal balance in disarray

25 Feb 2019


Saudi Arabia signed last week seven memoranda of understanding (MOUs) with Pakistan for up to $21 billion of investment over the next six years in three phases. No deadlines are in place to translate these MOUs into formal agreements. However, two bodies have been created for follow-up action.

The promise is about the future beyond a year. The present is challenging though on both external and internal fronts for a variety of reasons. For one, exports have struggled to pick up despite massive currency devaluations since December 2017 and subsidies without supported research or targets.

More recently, growth in the manufacturing sector tumbled to a negative 1.5 per cent for the first six months this year against a positive 7pc last year. That is where the hope for any substantial export growth in the near future falters as exportable surpluses fall. Foreign exchange reserves are yet to see a remarkable boost with all the injections from friendly countries inching towards repayments even though the current account deficit has declined significantly.

So instead of being adequately addressed on a sustainable basis, the immediate challenges have been delayed until the next year in the absence of early support from the International Monetary Fund (IMF), which would have revived financing from development lenders.

The notable challenge is already upon us on the fiscal front — revenues declining for the first time in recent history and expenditures going north — resulting in the half-year fiscal deficit of 2.7pc of GDP, highest after 2.9pc in 2010-11. This is despite a crucifying contraction in development spending having a direct bearing on the lives of people.

Defence spending surged 22pc in the first half of 2018-19 but development expenditure decreased 37pc amidst a rare decline in total revenue collection

Tentative timelines agreed upon during the recent visit of Saudi Crown Prince Mohammed bin Salman promised $7bn investment in the first two years. A major part of this flow worth $4bn is expected in existing LNG-based power plants in Punjab instead of any greenfield operation. This has to materialise through a bidding process. A $2bn MoU pertained to fresh investment by ACWA Power in renewable energy projects in the coastal areas of Balochistan and the Chaghi wind corridor.

These are subject to yet to be conducted feasibility studies. Another billion-dollar investment will be in the form of the Saudi Fund for Pakistan for spreads in projects like Diamer-Bhasha and Mohmand dams and Jamshoro power project.

The mid-term investment up to $2bn is anticipated in two to three years. These include smaller petro-chemical projects and food and agriculture projects of $1bn each. The long-term Saudi investment — over four to six years — worth $12bn is expected in two major projects: $10bn oil refinery to be set up by Aramco in Gwadar and $2bn investment in mineral development, probably in Reko Diq. The two are subject to feasibility studies.

That means unless foreign direct investment (FDI) increases from other avenues, its flows from Saudi Arabia will be insufficient to make a dent in the current account deficit and may be able to partially offset outflows on account of $46bn China-Pakistan Economic Corridor (CPEC) over the short to medium term.

In the meanwhile, the good sign is that the current account deficit has declined $1.7bn in seven months and fell almost 54pc to just $809 million in January. It was expanding by $1.5-2bn a month last year.

The bad sign, however, is that the decline was not supported by the trade account or FDI. While the exports grew by about 1.6pc, imports also went up by 1pc, thus creating less than 0.6pc savings on the trade account. FDI was in fact down almost 18pc to $1.45bn in the first seven months of the year. The major contribution of about $1.4bn came from remittances by overseas Pakistanis that is in itself a positive development.

More worrying is the almost non-existent correction on the fiscal front despite the government’s claims of austerity and greater fiscal discipline as all major indicators of expenditure and revenue depicted weakness. The fiscal deficit in the first half of the year rose almost 30pc to Rs1.029 trillion in absolute terms — a record.

Defence and mark-up payments surged 22pc and 32pc, respectively, while development spending plummeted 36pc. Half-year defence expenditure increased to 1.2pc of GDP from 1.1pc last year while the mark-up payments reached 2.3pc of GDP from 2.1pc. Total interest payments amounted to Rs877bn, up 32pc, in the first six months of the current fiscal year. Defence spending was up 22pc to Rs480bn.

Unfortunately, this led to a cutback on the Public Sector Development Programme (PSDP). Spending under the PSDP in the first half of this year plummeted to Rs328bn compared with Rs520bn last year, showing a reduction of 37pc or Rs192bn. This is also evident from the fact that overall development spending and net lending dropped to a paltry 1pc of GDP compared with 1.6pc last year.

As a result, the current expenditure went out of hand and amounted to Rs2.98tr in the first six months, up 18pc. The current expenditure stood at 7.8pc of GDP, significantly higher than 7.1pc of GDP last year. More alarmingly, the total revenue collection dropped to just 6.1pc of GDP against 6.6pc a year ago. Tax revenue was also down to 5.4pc of GDP against 5.6pc last year. Non-tax revenue went down 32pc in absolute terms.

The revenue performance in absolute terms was no better either. Total revenue stood at Rs2.33tr in the first half compared with Rs2.38tr last year, showing a reduction of Rs58bn or 2.43pc. This is perhaps a rare phenomenon that revenue collection has been lower than previous year’s and could not keep pace with inflation and the economic growth rate.

Published in Dawn, The Business and Finance Weekly, February 25th, 2019