THE important question as the ruling party is about to enter its fourth year in office is not whether it will complete its five-year term but whether it can rise above political expediency to steer the country out of the present economic crisis.
To be fair, the country’s current economic predicament is not entirely the making of the present government and can be attributed in the main to three perennial constraints within which the economy operates: (a) the massive public debt, both domestic and external, (b) the need to maintain a huge military establishment, and (c) the lack of tax culture together with the absence of political will to bring some holy cows (agriculture income for instance) within the tax net.
The first two constraints dictate that a large portion of the public expenditure is invariably allocated to debt servicing and defence, while the third constraint ensures that the public revenue, particularly from direct taxes, lags behind increase in government expenditure. The result is not only enormous fiscal deficit but also misallocation of resources. Add to these, the war on terror, which is telling upon the economy. According to the Economic Survey of Pakistan (2009-10), direct and indirect economic cost of the war on terror has exceeded $40 billion as increasing amount of already meagre national resources are being spent on security-related expenditure at the expense of development programmes.
Any assessment of the government’s economic performance as well as projections for the future needs to take into account the above mentioned constraints.
The most important economic challenge for the PPP government has been to ensure growth with stability. For a developing country like Pakistan, economic growth is always a major macro-economic objective. But, as Pakistan’s own experience shows, this growth has to be stable; otherwise, it will be difficult to sustain. The bursting of the bubble of economic growth in the beginning of 2008 — when the present government was installed — exposed the essential flaws in the economic policies of the Musharraf regime during which little was done to shore up the productive capacity of the economy and efforts were largely directed towards showing increase in economic numbers, such as GDP growth and rise in per capita income. Though the economy grew on an average at a healthy rate of 7 per cent per annum during last four years of the Musharraf period, the growth did not rest on strong fundamentals.
Hence, when the PPP government was installed, the economy was precariously placed. Fiscal deficit had increased to 7.6 per cent of GDP, while trade and current account deficits shot up to $21 billion and $14 billion respectively (at the close of financial year 2007-08). The government was accordingly forced to seek the International Monetary Fund (IMF) assistance and embarked on a macro-economic stabilisation programme, which put economic stability over growth.
A modest economic recovery was made in the financial year 2009-10 (FY10) as the growth rate increased to 4.1 per cent surpassing the 1.2 per cent revised growth rate for the previous fiscal year. Large scale manufacturing (LSM), which accounts for more than 70 per cent of industrial output, grew by 4.4 per cent compared with the negative growth of 7.4 per cent during the preceding year. Current account deficit came down to 2.3 per cent of the GDP from 5.7 per cent a year earlier. Fiscal deficit however exceeded 6 per cent of GDP surpassing both the revised target of 4.9 per cent and the actual figure of 5.2 per cent during FY09. Average CPI inflation dropped to 12 per cent from 20.8 per cent in FY09.
The major budgetary targets for the current fiscal year (FY11) included (a) economic growth of 4.5 per cent, average inflation of 9.5 per cent, (c) fiscal deficit of 4 per cent of GDP, and (d) tax revenue of Rs1. 66 trillion including direct taxes of Rs657.7 billion and indirect taxes of Rs1.12 trillion — 9.8 per cent of GDP.
However, the havoc wrought by the unprecedented floods in the country’s history — to the tune of $10 billion — led to downward revision of most of those targets. The floods washed away at least 1 percentage point of the potential GDP; therefore attaining growth rate in excess of 3 per cent will be a tall order.
Most of the development funds were diverted to rehabilitation and repair activities. Failure to bring about fiscal reforms, particularly imposition of the ‘reformed’ general sales tax (RGST), forced the government to approach the IMF for a nine-month extension of the credit programme.
During first six months of the current financial year (H1-FY11), current account surplus of $26 million was recorded as exports increased by 19.4 per cent to $11.12 billion and remittances increased by 16.7 per cent to $5.29 billion. In addition, $743 million were disbursed from the Coalition Support Fund (CSF). The current account deficit is projected to be 1.5 per cent of GDP for the full financial year.
Fiscal deficit, whose containment is the main pillar of the edifice of the government’s IMF-sponsored stabilisation policies, was to be reduced to 4.9 per cent of GDP during the last financial year (FY10). However, that revised target could not be attained as fiscal deficit rose to 6.3 percent of GDP exceeding 5.2 per cent in FY09. The fiscal deficit reached about Rs 500 billion (2.8 per cent of GDP) by the close of the first half of the current fiscal year and it is likely to significantly surpass the revised target of 4.7 per cent for the full year.
FBR tax collection during H1-FY11 grew by 13 per cent to reach Rs 661 billion against the target growth of 26 per cent. The Rs 1.66 trillion revenue target is difficult to achieve especially as tax reforms have been shelved. On the other hand, expenditure will continue to rise because of subsidies and security related expenditure. The decision not to pass the impact of the rising world oil prices to consumers has caused Rs 7 billion loss to the government during December-January FY11. The government may bear Rs 25-35 billion in additional cost by the close of the financial year in case it continues to subsidise the rising oil prices, particularly in the wake of the Middle East political crisis.
Not only the fiscal deficit but also the way it is being financed is a cause of concern. In the absence of considerable external assistance, the government is heavily relying on the banking system, particularly SBP credit for deficit financing. Between July 1, 2010 and January 15, 2011, the government borrowed Rs 352.2 billion from the banking system including Rs 133 billion from the SBP and Rs 222.2 billion from scheduled banks. Notwithstanding a rather restrictive monetary policy, strong inflationary pressures persist. In the first half of the current fiscal year, average inflation was 14.6 per cent and is projected by the SBP to be in the range of 15-16 per cent for the full FY11. The major cause of inflation is the fiscal deficit and the way it is being financed (bank borrowing). Another cause is the energy crisis driven aggregate demand-supply gap as there is both underutilisation of the existing production capacity and lack of new investment.
Resumption of the IMF assistance is another important issue. The IMF has so far disbursed $7.27 billion to Pakistan out of total agreed credit of $11.3 billion under a 25-month stand-by agreement (SBA) effective since November 2008. The programme was supposed to conclude at the end of 2010 but has been extended by nine months on the request of the Pakistan government to enable it to undertake the measures earlier agreed with the Fund. At the top of these measures is introduction of the RGST, which has become a contentious matter between the government and the opposition. There is no gainsaying the fact that Pakistan, which has one of the lowest tax-GDP ratios (9 per cent of the national output) in the world, needs to shore up public revenue. However, how this is to be done — by imposing new taxes or widening the tax net and curbing tax evasion — is the bone of contention.
Given strong opposition to the RGST both within and outside parliament, its imposition seems to be a difficult proposition. The most obvious consequence will be further delay in IMF disbursement, which will put pressure on Pakistan’s fragile balance of payment (BoP) position. Some time back, the federal finance minister expressed the optimism that the havoc wrought by the floods could provide the impetus for taking some tough decisions to contain the fiscal deficit. However, it seems that optimism was misplaced, as on account of political expediency the government has consistently shied away from taking such decisions. The decision to trim the size of the cabinet in the wake of devolution of several federal ministries to the provinces, though important, will by no means be sufficient to contain the fiscal deficit. While it may help reduce the current expenditure, the measures to push up revenue, such as introduction of the agricultural tax and controlling tax evasion by the businesses, remain in limbo. Besides, the impulse to survive may force the government to again enlarge the cabinet by inducting more ministers or deputy ministers from its allies with all their enormous perks and privileges.