NOTWITHSTANDING the most tumultuous events of September 11 and December 13, 2001, the continuing effects of the war on terrorism and the most heightened escalation on our eastern borders, the finance minister presented the third budget of the military government for the fiscal year 2002-03 with unusual calm containing almost no surprises.

The budget and the macroeconomic framework announced indicates continuation of the policies and agenda of stabilization in line with the structural adjustment programmes set out in the agreement with the IMF. While the previous year’s budget was announced in the backdrop of the IMF’s Standby Agreement (SBA), this year’s budget is largely in pursuit of the strategies set out in the Poverty Alleviation and Growth Facility (PRGF).

The most conspicuous change compared to the budgets of the past two decades this year is that the finance minister had no worries about our external account bankruptcy caused by weak foreign exchange position and recurring external account imbalances. With the foreign exchange reserves of $6 billion, the current account surplus of over $2 billion, the estimated workers’ remittances of over $2.2 billion, the significant reduction in our annual debt service repayments as a result of the re-profiling of the country’s external debt from the Paris Club, together with continuing liberal assistance from the IMF, the World Bank and the Asian Development Bank, the current year’s budget has been prepared with almost no risk of default over a medium term. Undoubtedly, these are the most notable achievements claimed by the government which had resulted from both, its commitment to follow the policies that are liked by the international financial institutions, as well as the reward for our support to the US-led coalition in the war against terrorism. As discussed below, despite these positive developments in terms of achieving external account stability, unfortunately there seems to be no end to the long spell of economic stagnation that Pakistan has gone through since 1996-97, when the GDP growth rate plunged to below two per cent (graph). Beset by the low growth in key economic sectors of agriculture and the large-scale manufacturing, the continuing stagnancy in exports and a depressed investment activity, the GDP growth during the year 2001-02 has been estimated at 3.6 per cent. Thus, the key agenda of the government for the revival of economic growth, despite the availability of larger resources in terms of enhanced foreign currency flows, the IFIs support and the external account solvency remains largely unfulfilled. Table.

Macro-economic framework: Consistent with the last two years’, the budget 2002-03 is also a part of the three-year (2001-2004) medium-term budgetary framework aiming at the revival of the economy. The key targets for the budget year and over this medium term period, as outlined in the speech are set out below:

1) The GDP growth target for 2002-03 has been lowered to 4.5 per cent compared to the 5 per cent announced last year. This is expected to increase to 5 per cent in 2003-04. Apparently, the targets have been reduced based on the better understanding of the ground realities and adverse economic conditions encountered during the last two years and continuing uncertain external environment (see graph).

2) Inflation is to be contained at less than 4 per cent throughout this period. With the inflation rate going down to less than 4 per cent during the current year, this does not appear to be a difficult target.

3) Gross investment to the GDP ratio is targeted to increase to 17.2 per cent by 2003-04. This seems to be an optimistic target and would be a major challenge keeping in view the outgoing year’s revised estimates of only 12.3 per cent and 14.3 per cent in the year 2000-01.

4) Fiscal deficit is to be reduced to 3.5 per cent of the GDP in the year 2003-04 from the outgoing year’s revised estimates of 7 per cent. Considering the performance of past 15 years or so, this is unlikely to happen. Historically, the fiscal deficit has remained above 7 per cent of the GDP.

5) Current account deficit is to be reduced to 1.8 per cent of the GDP and foreign exchange reserves are expected to rise to 18 weeks of imports.

Population and the GDP growth (Graph)

Current state of the economy: As per the Economic Survey 2002 issued by the government, the economic growth during the year is estimated to decelerate to 3.6 per cent compared to the budget target of 4 per cent. As against this performance, the target for 2001-02 as envisaged in the three-year economic framework announced with the budget 2000 was 6 per cent. The key reasons cited by the finance minister for the continuing poor performance of the economy are the adverse implications of the September 11 incident, which is estimated to have caused losses aggregating to $3 billion, escalating tension with India, prolonged drought conditions and slow-down in the world economy.

Whatever be the reasons, the fact remains that the Pakistan’s economy has remained in recession continuously for a period of last three years, with the average GDP growth rate falling to 3.3 per cent compared to 4.45 per cent in the 1990s (described as the lost decade). In other words, the average growth rate during the last three years is 26 per cent below that of the average growth rate during the lost decade. With the population growth of 2.7 per cent, the growth on a per capita basis would be almost imperceptible. Also, the most pervasive factor that affects the economy remains its over reliance on the agriculture sector. The agriculture contributes around 25 per cent to the overall GDP, but considering the nature of our industry and commerce that are largely agriculture dependent, its contribution in the national economy remains overwhelming. Consequently, the positive achievements in the external account and build-up of reserves did not result in the real economic revival owing to the paltry growth of only 1.4 per cent in the agriculture sector. The large scale manufacturing, another major sector of the economy, grew by only 4 per cent as compared to the previous year’s growth of 7.7 per cent. Key reasons for the sluggishness of manufacturing sector are low investor-confidence as reflected by the depressed level of gross fixed investment, which further declined during the year to 12.3 per cent of the GDP compared to 14.3 per cent in the previous year and the target of 15.2 per cent. The threat of war and the deterioration in law and order are alsomajor reasons underlying low investor-confidence, which the government has been unable to control. The abysmal level of investment activity and the lack of investor-interest is also reflected from the extremely low level of credit flow to the private sector, which declined to only Rs35 billion, one of the lowest in the country’s history. Due to the slowdown in world economy and the low investment activity, the exports also remained stagnant at previous year’s level of around $9 billion.

Another important area, where performance of the government has been below expectation is the CBR tax collections, which are expected to be Rs414 billion compared to the budget estimates of Rs458 billion for 2001-02 reflecting a short fall of Rs44 billion. In fact, the actual tax collections, based on 11 months’ collections of around Rs342 billion, are unlikely to exceed Rs400 billion. Therefore, the expected shortfall in the CBR tax collections is estimated to be around Rs58 billion. While the slowdown of economy and the lower imports have been cited as key reasons for reduced tax collections, this is far from satisfactory when viewed in the perspective that the tax reforms and the enhanced tax collections have been critical aspects of the government’s reform programme.

Fiscal deficit: In the budget 2001-02, the overall fiscal deficit was estimated to be Rs187 billion or 4.9 per cent of the GDP, which was projected at Rs3,796 billion. As per the revised estimates, the overall fiscal deficit is estimated at Rs257 billion, equal to 7 per cent of the GDP. A major reason for the increase in fiscal deficit to this level is due to picking up of the KESC’s losses in the form of equity injection, adjustment of the CBR refunds, shortfall in debt service payments from the public sector enterprises and an increase in defence expenditure owing to the escalation in border tension with India. The cumulative effect of these unusual charges is estimated at Rs80 billion. In fact, some of these adjustments such as the losses of public- sector enterprises, and the CBR tax refunds primarily relate to previous years’ deficits, which have been shown for the first time this year. This treatment confirms what has been repeatedly pointed out in my several articles in these columns in the previous years that all governments have been understating fiscal deficits by not showing huge losses of the public-sector entities as part of the fiscal deficit. Even now, the government has not included in the fiscal deficit, the huge losses incurred by some other public-sector entities and the overall fiscal deficit is still understated.

In any case, as the above estimates are based on the CBR tax collections of Rs414 billion, which are unlikely to exceed Rs400 billion, the actual fiscal deficit is likely to be over 7.4 per cent of the GDP.

It may be pertinent to point out that there exist major disparity between the Economic Survey and the budget documents, which was issued just two days after the Economic Survey. The fiscal deficit reported in the Economic Survey was 5.7 per cent of the GDP for 2001-2002, while in the budget documents, and in the finance minister’s speech, the overall fiscal deficit has been reported at 7 per cent. Such occurrences make the reliability of government statistics questionable.

Stabilization of rupee and external debt re-profiling: As discussed above, for the first time Pakistan’s foreign exchange reserves have shot up to over $6 billion. These reserves have been built as a result of a combination of factors, including the reduced debt servicing, steep increase in worker’s remittances, lower imports when compared to exports and purchases from the kerb market of around $4 billion in the past two years by the State Bank of Pakistan. The external debt of around $12.5 billion has been reprofiled by the Paris Club, which is likely to reduce substantially, the annual debt service obligations as well as the net present value of the external debt by around $3.5 billion. All these factors have contributed to a stable rupee against the foreign currencies including the US dollar. This stability has also helped in arresting the past trend of acceleration in the rupee cost of external debt servicing that used to be a big drain on the budget. Also, such stability has helped the government in reducing the interest rates, which has contributed in substantially lowering the government’s debt service cost on domestic debt. Unfortunately, even the stable rupee, an unprecedented level of the foreign exchange reserves, and very low cost of borrowing could not help in improving the investment activity due to the turbulent external environment and the inability of the government to induce demand through enhancing the public sector investment.

Budget estimates: Total budget outlay is expected to be Rs742 billion. This is lower by 1.3 per cent and 4 per cent, respectively, as compared to the budget estimates and the revised estimates of the outgoing year 2001-02. The current expenditure is estimated to be Rs608 billion and the development expenditure is pitched at Rs134 billion. The current expenditure is estimated to be lower by 2.3 per cent and 6.2 per cent as compared to the budget and the revised estimates for the current year, while the development expenditure reflects an increase of 3 per cent and 7 per cent respectively over the budget and the revised estimates of the year 2001-02.

The gross revenue resources, including the tax, non-tax revenue and the surcharges to finance this expenditure are budgeted at Rs675 billion showing an increase of 4.8 per cent and 6.6 per cent over the budget estimates and the revised estimates of 2001-02, respectively.

The net revenue receipts, after revenue transfers to the provinces of Rs194 billion (compared to Rs175 billion as per revised estimates of 2001-02), have been estimated at Rs481 billion indicating an increase of 5 per cent over the revised estimates of 2001-02. The net capital receipts have been estimated at Rs36 billion compared to Rs74 billion in the revised estimates of 2001-02.

The external financing is estimated at Rs198 billion, out of which Rs49 billion will be the project aid, while Rs140 billion and Rs9 billion will respectively be non-project aid and debt rescheduling. Thus, the aggregate external financing is expected to decline by 24 per cent and 34 per cent over the budget and the revised estimates respectively of the year 2001-02. Additionally, it is estimated that the provinces will generate Rs29 billion (compared to Rs17 billion and Rs15 billion as per budget and revised estimates for 2001-02) on their own to self-finance their public sector development programme.

The overall fiscal deficit has been estimated to be Rs163 billion or 4 per cent of the GDP.

Clearly, the government seems to have repeated the same errors, which it committed last year and all previous governments have been committing year after year of projecting highly inflated revenues and anticipating unrealistically low expenditure to reflect much lower fiscal deficits. As against the expected CBR tax revenues of Rs400 billion, the next year’s tax revenue is budgeted at Rs461 billion that are highly optimistic, when considering the past history as well as the fact that the budget year will be the election year. Based on the past performance and keeping in view the current ground realities, it appears that the revenues have been over-estimated again by at least Rs40 billion while the expenditure seems to have been under-budgeted by around Rs50 billion. Therefore, the government is likely to miss the above targets and the overall fiscal deficit is likely to go up to Rs253 billion or above 6 per cent of the GDP.

Economic outlook: Pakistan’s economic growth has, on an average, remained below 4.5 per cent in the decade of 1990s. In the past three years, this growth rate further plunged to around 3.3 per cent, which is slightly higher than the increase in population. During the last three years, the gross fixed investment as percentage of the GDP has further declined from 15 per cent to 12.3 per cent during the year. Despite various efforts, the dream of export-led growth has remained elusive, as our export base remains narrow and inelastic. With a very large proportion of the population living below the poverty line, at this rate of growth and investment activity, the problems of unemployment and economic deprivation have continued to escalate, and may get worse. As large majority of the population rely on agriculture for their livelihood, the steep fall in the growth rate of agriculture sector owing to drought and other factors including the price instability has further exacerbated their sufferings.

As against these negative factors, the stabilization in external account and a stable rupee, large foreign exchange reserves that are further increasing and enhanced external flows provide unprecedented opportunities for the government to reverse this trend of economic stagnation that has continued for too long.

While the budget includes some incentives such as reduction in corporate tax rates, incentives for mergers to financial institutions, enhancing the depreciation allowance and reduction in corporate tax rates, they are not considered sufficient on their own to revive the economy that has remained in deep recession since last over a decade. The most essential pre-requisite for the economic revival would be some tangible efforts to revive the agriculture productivity on which depends most of our industry also. This, certainly requires substantial investments in building agriculture-related infrastructure, including irrigation, drainage and agriculture research that have long been neglected. Further, there is a need to provide some price stability to protect the farmer. While the US and the European Union provide huge subsidies to farmers estimated at $400 billion, we do not even provide the most essential minimum price protection of the major crops. Our spending on nation- building functions such as education, health, sanitation etc., have remained low and have been declining due to lower revenue transfers to the provinces.

It is due to the above factors that so far, the economic revival has remained elusive and seemed somewhat unachievable. The poverty alleviation programme, in the form of Khushal Pakistan Programme (KPP) and the Khushhali Bank have not made much of a difference to poverty. Therefore, there appears to be no credible basis underlying some of the optimistic targets envisaged in the budget.

Despite some successes, Pakistan is still faced with severe economic and financial crises that are deepening with the passage of time. Among its problems include a large debt burden, the increasing defence requirements due to a hostile neighbour, escalation in terrorism and the deteriorating law and order situation, the ever-increasing fiscal deficits, the low tax base, an abysmal rate of savings, the declining investment due to erosion in investor confidence, the continuing trade deficits, a narrow export base, poor state of its human resources and the infrastructure, a crumbling public sector, the inequitable distribution in the legislative responsibilities and revenues between the federation and the provinces, and a highly inefficient bureaucracy. The cumulative result of these matters is aggravating poverty and unemployment and further eroding the investor confidence. Considering the above problems, it is not difficult to comprehend the enormity of the challenge for any government to turn around the economy. Nonetheless, the governments excessive focus on the IFI-sponsored stabilization policies, some of which have been perceived to be detached from the ground realities, slow decision making and ineffective monitoring mechanisms are the real causes that have aborted all attempts made for revival of the economy.