An official review

February 24, 2020

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Against the backdrop of the increasing public criticism over the slowing economy, rising inflation and the struggling job market, the economic managers have tried to assuage the political leadership that their steady policy mix, supported by the International Monetary Fund (IMF), is adequately addressing the macroeconomic imbalances.

But make no mistakes, a shift to populist mode under political compulsions could wipe out hard-earned achievements in no time, the Ministry of Finance warned the federal cabinet in its Mid-Year Budget Review Report 2019-20 on February 20 as required under the Public Finance Management Act 2019.

“It is imperative to continue with the adjustment process to further gain from the visible stability seen in terms of the falling twin deficits. The policy continuation is warranted given the lingering vulnerabilities in the economy and the chronic nature of structural challenges,” the report said.

It pointed out that there were five critical risks in achieving fiscal sustainability which can compromise the desired results. These include substantial shortfall in tax revenue (as clearly evident by now), unexpected volatility in the exchange rate, losses and circular debt in the energy sector, increase in pension expenditure, liabilities and unexpected public debt, and financing of fiscal deficit.

In the first half of the year, the economy moved progressively along the stabilisation path, with the structural adjustment process picking up momentum with the initiation of the IMF programme, said the report. The affect of the State Bank of Pakistan’s (SBP) continued monetary policy consistent with medium-term inflation targets and consolidation efforts on the fiscal front are visible on the revenue and expenditure sides.

A shift to populist mode under political compulsions could wipe out hard-earned achievements in no time

Despite a massive shortfall, the finance minister said the Federal Board of Revenue actively pursued improvement in documentation efforts, including asset revaluations, tight financial scrutiny and introduction of structured mechanisms to formalise business value chains. The prime minister and other cabinet colleagues were told that the success of documentation measures hinged upon policy consistency and would manifest in revenue mobilisation over the medium term.

The stabilisation effort had resulted in declining twin deficits of the current account and fiscal account. During July-December 2019-20, current account deficit (CAD) was reduced by 75 per cent, exports increased by 4.5pc, worker’s remittances by 3.3pc and foreign direct investment grew by 68.3pc. On the other hand, the fiscal deficit was contained at 2.3pc and the primary balance posted a surplus of 0.6pc.

Total public debt was recorded at Rs33.707 trillion at the end of December 2019, compared with Rs32.708tr at the end of June last year, registering an increase of only 3pc during the first six months of 2019-20. Though the government borrowing during this period was Rs1.546tr, total public debt increased by Rs999 billion, providing Rs547bn saving/differential due to exchange rate appreciation.

The finance ministry said the market’s willingness to lend to the government for long tenors at rates below the policy rate was a reflection of the general confidence in macroeconomic policies. Also, the finance ministry claimed credit for the interest expense remaining significantly less than the budgeted amount during this period.

Against the budget estimate of Rs1.4tr, actual interest expense was recorded at Rs1.281tr. This was achieved partly due to re-profiling of short-term debt into long-term debt and partly due to a sharp decline in the cost of borrowing in longer tenors. In line with the government’s commitment, no new borrowing was made from the SBP during this period as advance borrowing had been booked in the last fiscal year. “In fact, there was a net retirement of Rs285bn in the outstanding debt obtained from the SBP in previous years”.

Fiscal consolidation measured have brought financial discipline and increased revenue growth by bringing about stability in the economy and it is expected that a path of sustainable economic growth can be achieved. The positive trend in ease of doing business, stable exchange rate, improved current account and better fiscal and monetary management, denote that the economic outlook seems promising, the finance ministry said.

The ministry conceded that the FBR revenue target of 2019-20 was very challenging, unprecedented and the highest ever, keeping in view previous year’s allocations and actual collections. But it claimed that the performance of the FBR in the first half of 2019-20 was very encouraging. “However, in order to achieve the annual revenue target, a lot of efforts have to be taken by the tax functionaries,” said the ministry.

The success of documentation measures hinged upon policy consistency and would manifest in revenue mobilisation over the medium term

“Any shortfall in the achievement of these targets in tax revenue collection will have adverse consequences for the projected fiscal position of the government. One of the consequences of failing short on revenue targets would be the curtailment in development expenditures”.

Talking about the financial outlook, the ministry said it was evident that the external financing needs were higher over the second half of the ongoing fiscal year. Any shortfall in external financing would require the government to bridge the gap through the domestic debt market.

However, the current favourable trends being witnessed in the domestic debt profile signify that it is projected to improve considerably by the end of the current fiscal year. The proportion of debt held by the SBP is also expected to decline and the proportion of debt raised through long-term instruments is likely to improve. Interest expense for the full year is expected to be lower than the budgeted amount.

Supported by lower-than-budgeted borrowing costs, fiscal deficit and a stable exchange rate, the debt-to-GDP ratio is projected to decline from 84.8pc at the beginning of the current fiscal year to below 83pc by end of the year. This is a welcome development considering the emergent need to lower the debt-to-GDP ratio over the next few years and bring it below the ceiling of 60pc set by the Fiscal Responsibility and Debt Limitation Act 2005, the finance ministry hoped.

Published in Dawn, The Business and Finance Weekly, February 24th, 2020