Budget in focus

By Dr. Muhammad Yaqub    

The budget for FY14 was delivered while the campaign promises of the PML-N leadership were still ringing in the ears of the nation. Since the government didn’t have the time to install a new economic management team at the technical level, it relied on the same bureaucrats that have been fudging fiscal data and, at times, issuing false budget projections. As a result, the FY14 budget is based on unrealistically optimistic projections of resource availability and includes a hotchpotch of ad hoc policy measures.

Moreover, there were obvious statistical discrepancies, analytical flaws and policy contradictions in the finance minister’s budget speech. While he conceded that the economy is in a state of disarray and rightly blames the previous government for economic mismanagement, his own policy prescription does not measure up to the task. Lofty targets have been set for the next fiscal year and for the medium term that are not backed by commensurate policy effort.

The budget speech started with an accurate description of the state of the economy: an annual growth rate of three percent and inflation rate of 13 percent in the last five years; massive depreciation of the exchange rate and depletion of foreign exchange reserves; rising poverty and unemployment; large scale energy shortage; bankruptcy of the public sector enterprises (PSEs) and a mountain of public debt. In highlighting these problems, the finance minister conveyed the impression that the new government is serious about addressing the fundamental structural economic imbalances.

The budget speech also rightly emphasised the need for financial discipline, investment and growth. There is a promise to accelerate the rate of economic growth to seven percent by FY16 by raising the investment level to 20 percent of GDP. The budget deficit is to be reduced by about 2.5 percent of GDP while development expenditure is to be increased by 50 percent. There is a commitment to reduce the budget deficit to four percent of the GDP by FY16. During the same period, massive expenditure is proposed to build highways, run bullet trains, develop infrastructure, give subsidised loans to the youth, provide housing to low-income people, bail out loss-making enterprises and finance income and price subsidies.

           
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At the same time, it is promised that reliance on external inflows is to be reduced and there is a hint that government borrowing for budgetary support from the State Bank of Pakistan (SBP) will be stopped. Individually, these are laudable goals but cannot be realised without fundamental structural economic reforms. A few cosmetic expenditure saving and ad hoc revenue raising measures will fail to achieve them.

The proposed 30 percent reduction in non-debt servicing, non-defence and non-salary expenditure in the public sector will not dent the budget deficit by much, although it will signal the adoption of an austere lifestyle. A massive revenue mobilisation effort, both at the federal and provincial levels, will be needed to achieve the target of the tax-to-GDP ratio of 15 percent by FY16. An inflation target set at single digits will require a tight monetary policy to work off the excessive overhang of liquidity injected in the economy through a high rate of monetary expansion in the last five years. Indeed, the country desperately needs a road map of structural economic reforms for financial stability and economic growth but the budget does not have it.

On the external front, the budget speech makes no mention of the looming foreign exchange crisis and contains no views on the burning need – as well as the precise timing – to approach the IMF for a bailout to avoid a potential debt default. To the contrary, the budget promises to increase the country’s foreign exchange reserves to $20 billion by FY16 and reduce reliance on foreign inflows, without any mention of how to get there.

But a budget that makes promises without commensurate policy actions should provide no comfort to its framers or to the public at large. We have been down that road before without ever reaching the goal post.

If one looks at the budget documents of all the governments in the last two decades, it is clear that all set very sound macroeconomic targets in the beginning of the year without having policy programmes to achieve them. The result was that, year after year, the actual outcome was vastly different from the budget targets.

Give the history of rosy promises and economic mismanagement and a very grim economic situation, the government should have broken new ground in preparing the budget for FY14 but it hasn’t. Deep-rooted structural problems cannot be wished away without painful policy measures sustained over an extended period nor can the problems be concealed by ad hoc patchwork.

At the macro level, the country is caught in a state of stagflation which combines a low rate of economic growth with a high rate of inflation. In broad terms, the country is trapped in three interrelated structural macro imbalances. The first is the gap between the required rate of investment to achieve a potential growth rate of 68 percent per annum and the current rate of national savings.

Second, is the imbalance between government expenditure and revenue manifesting itself in a large deficit in the consolidated public sector operations that has in the past been filled with large domestic and external borrowings. Third, is the gap between current external receipts and payments that necessitated large scale borrowing from abroad to bridge the foreign exchange deficit.

The government needs to develop an internally consistent macroeconomic framework and mutually reinforcing economic policies to get rid of these macro imbalances. A growth rate of seven percent would require an investment level of around 20 percent of the GDP but to be consistent with the target of maintaining a single-digit inflation rate and reducing dependence on foreign inflows, policies have to be framed to raise the existing domestic rate of saving of 8.7 percent of the GDP to about double that size. The public sector is a net dis-saver and will remain so in the foreseeable future. Consequently, the private sector will have to generate savings at a much higher rate to achieve the above goal. The budget gives no policy framework to increase the domestic saving rate to that level. In the absence of a substantial increase in the domestic rate of saving, neither the inflation target can be met nor can the desire to reduce dependence on foreign inflows be fulfilled.

Similarly, reduction in the budget deficit to four per cent of the GDP in the context of sharp acceleration in the development expenditure and inflexibility in the heavy burden of debt servicing and defence expenditure would necessitate a massive resource mobilisation effort. The symbolic austerity measures to reduce non-debt servicing, non-defence and non-salary expenditure by 30 percent are a welcome exercise in public relations and so is the abolition of discretionary or secret funds and a cut in expenses of the presidency and the prime minister’s office. But their financial impact on the budget will be insignificant.

            

Similarly, the introduction of a few withholding taxes, raising sales tax by one percentage point, increasing reliance on scattered indirect taxes and burdening the already heavily taxed sectors with more tax  will not help achieve fiscal targets, promote growth or contain inflation. The nearly two-thirds of the recorded GDP emanating from the services and agricultural sectors, and a large part of the unrecorded underground economy, will have to be brought under the direct tax net. Moreover, a generalised consumption tax of value-added variety at a low rate and large scale documentation of the economy would be required to realise the tax-GDP ratio of 15 percent targeted in the budget for FY 16.

The balance of payments viability and the reserve target mentioned in the budget can only be achieved by a sharp acceleration in exports, curtailment of imports and an inflow, rather than outflow, of capital by residents. It requires a revamping of the policy framework to promote export growth and make it attractive to save and invest at home rather than indulge in capital outflow. The finance minister gives no outline of reducing the trade deficit as a prerequisite to lower dependence on capital inflows and build up foreign exchange reserves without further borrowing from the IMF and other foreign sources. Sale of national assets to foreigners to raise foreign exchange resources, borrowing from the international market or begging friendly countries for assistance would conflict with claims of self-reliance and a desire to preserve national sovereignty, and even then, will only postpone the inevitable balance of payments crisis.

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It is about time that the political leadership understands the real economic situation, musters courage to share economic realities with the people and prepares them for hard policy choices required to address the above-mentioned interrelated macroeconomic imbalances. The time for patchwork making has passed.

The writer is a former governor of the State Bank of Pakistan

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