• In report on fiscal risks, country’s finance team lists climate change among nearly dozen challenges to budget, medium-term outlook
• Ministry calls for comprehensive measures to address fiscal challenges

ISLAMABAD: The government has highlighted almost a dozen critical risks to next year’s budget and medium-term outlook, including higher interest rates, currency depreciation and greater subsidy requirements, challenging revenue targets, lower than estimated economic growth, unexpected climatic or natural disasters and continuing poor performance of State-Owned Entities (SOEs).

In a written statement of fiscal risks submitted to parliament, required under the Public Finance Management Act 2019, Finance Minister Muhammad Aurangzeb and Secretary Imdadullah Bosal said that a combination of three risks — higher than the estimated interest rate, lower than non-tax revenue collection and higher subsidies — had the most significant impact on fiscal variables across the board.

“The combination of reduced revenues, increased expenditure on subsidies, and potential financing needs due to higher interest rates lead to substantial fiscal deficit and higher debt stock,” it said, underscoring the interconnectedness of fiscal policy and the need for comprehensive approaches to address fiscal challenges.

These risks are critical in view of a record Rs12.97tr revenue target for the FBR for next fiscal year, up 40pc from Rs9.415tr missed target during this besides a mammoth Rs2.5tr funds expected from State Bank profits.

However, both the technocratic and bureaucratic heads of the Ministry of Finance do not see the prevailing political situation and weak coalition government to be of any risk to the fiscal and economic plans of the newly formed federal and provincial governments.

It said any increase in the interest rate on external and domestic debt could lead to a rise in federal expenditures and subsequently, the federal fiscal deficit and total debt of the government. “If this possibility is realised, the overall effect will be substantial without additional measures.” Based on current projections, the federal fiscal deficit for next year is estimated at Rs8.5tr or about 6.9pc of GDP.

The statement said a significant reduction in non-tax revenue collections could also lead to a substantial decrease in net federal revenue and a consequent incre­ase in fiscal deficit. “Additionally, the higher deficits contribute to an increase in debt stock over the forecasted period.”

While the government has pitched more than Rs1.363tr for the next fiscal year, the ministry said the increase in subsidies leads to an increase in expenditure, and the effect on fiscal deficits and debt stock is relatively limited. Higher subsidies support the targeted sectors or programs but “may also strain government finances if not accompanied by corresponding revenue measures or expenditure controls”.

Talking about the fiscal risk arising out of lower GDP growth, the statement said this envisaged lowering the projected GDP growth rate by a quarter in each fiscal year over the medium-term budgetary framework. “While this scenario does not directly affect fiscal policy measures, it has implications for revenue generation and expenditure planning,” according to the statement explaining that the lower GDP growth rates lead to a decrease in net federal revenue due to subdued economic activity.

“Consequently, there is pressure on fiscal deficit and debt accumulation, as the government may need to maintain or increase expenditures to stimulate growth amid lower economic performance.”

Moreover, the ministry warned that the more-than-expected depreciation of the rupee to significantly impact fiscal sustainability by increasing the cost of servicing external debt, as repayments and interest on foreign-denominated loans become more expensive in local currency terms. “Additionally, a weaker rupee can lead to higher import costs, fueling inflation and putting pressure on public expenditure, particularly if subsidies on essential goods like fuel and food are in place,” it said.

As a result, the combined effect of these factors could lead to a higher fiscal deficit and an increased debt burden, exacerbating fiscal vulnerabilities. “Moreover, the depreciation could undermine investors’ confidence, leading to capital outflows and further currency depreciation, creating a vicious cycle of financial instability.”

Climate change

Similarly, the government highlighted that despite being an almost negligible contributor to global warming, the costs of climate change to Pakistan were not only substantial but continuously increasing as the country faced severe economic challenges. “The accelerated impacts of climate change have added a new layer of pressure on the economy, including the exogenous shock of severe climate disasters, which in 2022 exerted significant losses on GDP,” it said, adding that rising inflation, high indebtedness, low growth, currency depreciation, and depleted foreign currency reserves have added to the scale and multitude of challenges.

It also pointed out that stringent climate change mitigation could significantly raise government expenditures and resultantly, the federal fiscal deficit. However, it will also yield economic and climate benefits in the medium and long term, restricting the average degree temperature to increase significantly. “As such, it is critical to highlight that climate change is a long-term phenomenon, requiring climate justice by the international community to join hands with Pakistan to make joint efforts for climate change mitigation,” it pleaded.

The statement of fiscal risks warned that under no or lower efforts to climate change mitigation, the loss to GDP will be greater than the stringent mitigation scenario. “On the fiscal side, the decreased revenue collections due to less economic activity and lower productivity may yield a higher fiscal deficit. Furthermore, climate change mitigation along with efforts for more revenue collections are more promising in the long term for fiscal sustainability in line with the baseline scenario”.

Recalling the 2022 floods and the vulnerabilities this disaster caused, the statement called for the creation of a “Natural Disaster Fund (NDF)” to help mitigate fiscal deficit, at least to some extent.

The finance minister also highlighted the risks arising out of poorly performing SOEs that cause almost Rs1tr in annual loss and their accounts pose financial risks to the sovereign. Additionally, severe weather conditions due to climate change lead to shifts in water availability and energy generation, while major precipitation events, extreme temperatures, and wildfires disrupt transportation infrastructure and transmission systems.

Therefore, the Ministry of Finance emphasised stable macroeconomic policies to prevent excessive exchange rate fluctuations and attract long-term investments, contributing to overall economic resilience and minimising fiscal risk, while simultaneously accumulating foreign exchange reserves for a financial cushion against exchange rate volatility. During such a period of economic stability and favourable trade balance, the government could build foreign currency reserves and manage these reserves through investments in safe and liquid assets and support export-driven sectors for increased foreign currency earnings and improved trade balance.

Published in Dawn, June 17th, 2024

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