“Defence is of much more importance than opulence;” thus wrote Adam Smith, the author of Wealth of Nations. Today defence requires not only a strong standing army but also a modern defence industry capable of providing latest high tech weapons for the army; alternatively weapons would need to be imported.
The administration of justice and maintenance of law and order are of no less importance. Also governments have to provide social and economic services like education, health care and physical infrastructure,like transport and communications, energy, environment, water, sanitation and housing. The provision of physical infrastructure by the government is a prerequisite for promotion of private investment activity in the economy.
Governments need resources to meet expenses on provision of these services; the larger the availability of resources to the government, the larger and better the services they would be able to provide. The source of government revenue is imposition of taxes, duties etc. on production, income and consumption of goods and services. Like any other economic unit government may have a surplus, balanced or deficit budget. However, owing to its sheer size and implications of taxation for allocation of resources in different uses, government budget has a far reaching impact on the growth rate of the economy as also on distribution of income and wealth among people.
The fiscal deficit is generally of two categories i) overall fiscal deficit, and ii) revenue deficit. However Pakistan has come up with a third category, viz, ‘primary balance’ as an indicator of fiscal health of the country. The overall fiscal deficit is excess of total expenditure of the government on its total resources. The revenue deficit is excess of current expenditure of the government over its revenue receipts. The primary balance has been defined by GOP as a deference between total revenue receipts and total expenditure excluding interest payments. It is pertinent to point out that budget deficit discussed here is that of the consolidated public sector. The relevant data in this regard for the period 1972-2003 is set out in the accompanying table on summary of Public Finance:
The GOP is committed to the IMF to gradually bring down the level of overall fiscal deficit to an agreed sustainable level. The reason is that low level of fiscal deficit is considered to be a sine qua non for economic stability; which, in turn, is essential for the promotion of private productive activities. The increase in the share of public sector in total effective demand is also frowned upon because it is believed that this crowds out private sector.
It would be evident from the table that the annual average ratio of overall fiscal deficit to GDP (MP) declined from 8.1 per cent during 1972-80 to 7.0 per cent during 1980-88; remained at that level during 1988-96; and fell to 6.2 per cent during 1996-2003. A further breakup reveals that this ratio fell to 6.7 per cent during 1996-2000 and further to 5.4 per cent during 2000-03. It is expected to be as low as 4 per cent during FY 03.
This conceals four disturbing developments. Firstly, the public sector’s development expenditure registered a sharp decline during this period.
Secondly, the annual average ratio of revenue surplus to GDP at 0.6 per cent during 1972-80 turned to revenue deficit of 0.1 per cent of GDP during 1980-88. The reason was that revenue deficit, starting in 1984-85, became a permanent feature and started mounting with the passage of time. The annual average ratio of revenue deficit to GDP rose to 1.9 percent during 1988-96 and further to 2.7 per cent during 1996-2003.
Let us put it differently. Between 1984 and 1988, government used Rs40 billion of borrowed resources for financing of current expenditures. This amount increased by Rs150 billion to Rs190 billion by end June, 1995; and rose sharply by Rs613 billion to Rs803 billion up to end June, 2002. It is expected to increase further by Rs32 billion to Rs835 billion by end June, 03. Thirdly, the annual average ratio of interest payments to GDP (MP) increased from 2.0 per cent during 1972-80 to 3.4 per cent during 1980-88; it rose further to 5.5 per cent during 1988-96; and still further to 7.1 per cent during 1996-2003.
The ratio of expenditure on defence to GDP rose from 5.7 per cent in 1972-80 to 6.5 per cent during 1980-88, but declined to 6.2 per cent in 1988-96 and further to 4.5 per cent during 1996-03.
The ratio of current expenditure, other than on defence and interest payments, to GDP increased from 6.9 per cent during 1972-80 to 7.2 per cent during 1980-88; and further to 7.7 per cent during 1988-96; but fell marginally to 7.6 per cent during 1996 -03.
Finally, the mounting increase in government borrowings to finance non-development expenditure and the attendant increase in interest payments had implications for total public debt which increased from Rs54 billion (Rs17 billion) in June, 1972 to Rs145 billion (Rs59 billion) in June, 1980; to Rs521 billion (Rs289 billion) in June, 1988; to Rs1922 billion (Rs1042 billion) in June, 1996; and in the next 5 years more than doubled to Rs. 3866 billion (Rs1713 billion) by end June, 2001. It declined to Rs3760 billion (Rs1695 billion) by end June, 2002. (The figures in parentheses pertain to domestic public debt). It is our considered view that not only the IMF conditionality concerning reduction in overall fiscal deficit is harmful for the economy but also measures taken to achieve this objective are questionable.
Non-development expenditure: In fiscal policy, the tradition was to control non-development expenditure of the government to the barest minimum level and channel revenue resources to the provision of social and economic services as far as possible. Moreover, government could borrow resources from the public to the maximum extent feasible with a view to providing physical infrastructure. Such borrowings by the government are not a burden but are highly beneficial as investments in infrastructure such as roads, bridges, harbours, dams, hydal power plants, not only pay for their cost and maintenance but could be a source of considerable revenue for the government.
However, owing to the analysis in the current economic literature in vogue in Bretton Woods Institutions, of the role of fiscal policy under highly unrealistic assumptions, the emphasis has wrongly shifted, from harmful implications of sharp and persistent increase in non-development expenditure being financed with borrowed funds and the need to control it, towards adverse effect of large overall fiscal deficit on macroeconomic stability.
These assumptions, among others, include: i) the consolidated public sector budget deficit is for financing of non-development expenditures of the government; ii) saving is a given or constant function of GNP; iii) saving and investment take place only in the private sector; iv) all borrowings of the private sector are for financing of investment expenditures; v) private sector’s savings, if not mobilized by the government, would necessarily flow towards financing of private investment expenditures directly or through banks and NBFIs; vi) the increase in reserve money is a source of finance to the government for incurring non-development expenditure. This approach towards fiscal deficit has played havoc both with overall saving effort in the economy and the government’s investment activity for building up infrastructure in the country.
Fixed capital formation in the public sector had been substantially higher than that in the private sector during 1972-89. Thereafter, its share started declining, yet it constituted about 48 percent of total fixed capital formation in the economy during 1989-96. Capital formation in the public sector fell to extremely low level in the past seven years. As a result, development of infrastructure of the economy received a severe setback during this period. It is well known that developed infrastructure is a pre-requisite for facilitating larger investment effort in the private sector. The main factor responsible for this setback was the imposition of targets for overall fiscal deficit.
There is no denying the fact that the public sector has to invest huge amounts in projects with long gestation periods that are socially desirable and, at the same time, contribute to more production due to attendant external economics. Public sector, like private investors has to supplement its own resources with borrowed funds. Next to monetary assets offered by the banking system, the instruments offered under NSS are most popular with the household sector. The mobilization of resources by the banking system has to be tempered with considerations of price stability.