Wither fiscal space!

Wither fiscal space!

Waqar Masood Khan

The Prime Minister on Wednesday has unveiled a program of poverty alleviation under the Benazir Income Support Program (BISP), named ‘Ehsas’. In the launching ceremony, he announced opening of a dedicated new ministry for this purpose. This would combine all social safety net programs in a single-window focusing on poverty reduction in a comprehensive manner. We are increasing spending for backward areas to Rs.80 billion and this amount would be increased incrementally to Rs.120 billion. The government would provide cash to 5.7 million women through saving accounts along with a mobile phone to have access to their bank account. The stipend of cash transfer will be increased from Rs.5,000 to Rs.5,500. Tahafuz programme would be available at a call distance to the people in difficulty for legal aid as well as educational grants and health facility to those who do not have Insaf Health Cards. We will also coordinate with the non-governmental organizations to provide assistance to bonded laborers, gypsies and members of transgender community, etc. The government has decided to help the poor women in rural areas by providing them goats and chicken, as this is tried and tested model across the world, as well as seeds for kitchen gardening”.

The goals set by the Prime Minister are laudable and are indeed highly desirable. Although some estimates for individual schemes have been indicated, full costing of all the programs and interventions are not provided. Be that as it my, the real challenge his government faces is lack of resources. There is no fiscal space available to pursue such ambitious programs. There are two basic reasons behind this state of finances.

First, under the existing revenue sharing arrangements between federation and provinces, there is no scope for undertaking such programs from government’s share of revenue. It is both an issue of resources as well as constitutional responsibility. Second, the country is passing through a major economic slow-down, which would only deepen with time, especially when the IMF program will start, which would prevent adequate resources in the public sector for supporting a major intervention in social sectors. We would elaborate both these factors in some detail.

We use the last fiscal year’s data to illustrate the current state of fiscal finances. The gross revenues in 2017-18 were Rs.4.7 trillion, of which Rs.2.2 trillion (or 47%) were transferred to the provinces, leaving a net revenues of Rs.2.5 trillion for the federal government. This amount of resources was woefully inadequate to meet the expenditure requirements of the federal government. Let us see this. The debt servicing and defense expenditure alone amounted to Rs.2.6 trillion, which is higher by Rs.114 billion from the net revenues. This means we have to borrow to meet a part of even such basic expenditures.

We next look at current expenditures which include running of civil administration, subsidies, pensions (civil and military), health, education, housing and social protection. Beyond debt servicing and defense, current expenditures are Rs.1.2 trillion. With the excess of Rs.114 billion noted earlier, the total excess over net revenues is Rs.1.3 trillion. All these sums are met through borrowing.

But wait, this is not all. There is development expenditure also. A sum of Rs.890 billion was spent on development. That takes the total expenditure to Rs.2.2 trillion (or Rs.2223 billion including some Rs.25 billion that provinces overspent through borrowings). This staggering sum, which was the fiscal deficit of last year, is funded through borrowing both domestic and foreign. This is, therefore, the resource position of the federal government. It is run on sheer borrowing.

The Prime Minister often laments why the public debt is rising and where the borrowing sums are going. Well, this is the state of affairs. All activities funded from borrowing have been noted. There is a portion for development spending which also includes Rs.150 billion spent as a current expenditure This comprises such expenditures like the BISP cash transfer program and various subsidies like textile, fertilizer, tractors etc. More importantly, as the Finance Minister pointed out during his speech at the second mini-budget, there is a phenomenal sum of expenditure already incurred and not recognized in the budget. The circular debt, unpaid refunds, subsidies and non-passage of increased administrative prices of gas and electricity are those expenditures not yet brought in the budget. With their recognition, the deficit would rise still further.

A large part of this expenditure is unproductive, as no assets are created and no future income is expected from them. Accordingly, such deficit is largely adding to public debt without spurring growth and contributing to rising debt to GDP ratio, which last year climbed to 73% from 67.5% a year earlier.

The fiscal affairs during the current year have only worsened, most notably poor revenue collections and huge over-runs in current expenditures, notably for debt servicing and defense, which would wipe out any savings from cutting development spending. Analysts are estimating that the fiscal deficit would be anywhere from 7%-7.5%.

Let us turn the attention to second reason, namely the further deepening of economic slow-down. All the excesses that we have noted above will have to be checked soon when the government enters into an IMF supported reforms program. The fundamental nature of the program would be to contain the aggregate demand primarily unleashed by run-away fiscal deficit. The instruments for the purpose, other than outright fiscal adjustment (a 2% reduction in deficit in the first year mostly through additional tax effort) are appropriate adjustments in interest rate and exchange rate. The structural reforms in the energy sector would call for full passage of prices determined by the regulators and any gap would have to be provided in the budget. However, the IMF would protect BISP expenditures while demanding major cuts in other expenditures.

All these actions would cause two inevitable outcomes: rising inflation and slow-down in growth. But these are not necessarily bad outcomes for about two years as this would constitute the cost of stability. The bleeding of foreign exchange would stem, economic management would be monitored through a quarterly review process. The discipline entailed by the program would inspire investors’ confidence and hence gradually the growth process would revive. Fiscal adjustment would yield room for private sector credit. Furthermore, the program would also enable the country to access international capital market for funding, which would create more room for private sector credit in the domestic market. All these developments would pave for the revival of economy.

There are three observations we would like make for Prime Minister’s consideration. First, the current revenue sharing arrangements are premised on the fact that the social sector spending would be made by the provinces and the remaining envelop being quite insufficient to meet the cost of the programs under Ehsas. Second, the need of the economy is stability, which requires expenditure controls and hence there is not much room for taking large spending programs. Finally, the government should prepare people’s minds for economic slow-down and impending inflationary pressures. A cogent and well-reasoned narrative is required for people to face the tough times that lie ahead of us.

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