The fiscal headache

The one element that the federal government is unable to control in its early days is the fiscal deficit. On consolidated basis, the deficit stood at 2.7 percent of GDP in 1HFY19 - highest since 1HFY13. The deficit had reached 8.2 percent of GDP in FY13.

This does not, however, mean that history is repeating itself, as some measures in the second half of FY19 would not let deficit slip that fast. That said, it won't be a surprise to see the number at 6.5 percent of GDP for FY19.

The problem is in revenue generation which on consolidated basis fell by 2 percent while tax revenues are up by a mere 4 percent. The writing was on the wall - government has a clear strategy of import compression and that is having a toll on FBR revenue collection. As much as 43 percent of FBR revenues in FY18 were collected at import stage. (read "Import compression and taxation", published on January 16, 2019).

The challenge is to implement a structural change by reducing tax dependency on imports by moving towards local sectors for tax collection. It is not an easy task and will take time, and in the process, tax revenues growth may remain abysmal.

An easier way could have been to increase the GST rate or having higher indirect taxes in direct tax collection by taking the Dar route. However, the finance ministry does not seem to have any inclination to adopt that path and in the process, short to medium term macroeconomic stability would remain a challenge. Assuming the IMF programme is approved by FY20 budget, there might be cases of higher incidence of tax on existing base for next year.
In order to sustain IMF pressure, it is imperative to show some signs of improvement in the second half of the fiscal year. The government has increased the petroleum levy on diesel from earlier levels – collecting Rs10/ltr and Rs14/ltr on petrol and diesel respectively. The good thing about PL is that it does not have to be shared with provinces and federal government can use all the incremental revenue for deficit reduction. The idea was initiated by Miftah last year and now Asad is capitalizing on it.

Then there is positive impact of gas and electricity prices increase in reducing fiscal deficit. But this would not be enough to increase taxation to desired levels as government has to be successful in taxing the untapped. A simplified process is promised as a pilot in Islamabad – it remains to be seen how quickly is it expanded to the whole country. But do not expect miracles in next 12-18 months.
The other reason for dip in FBR revenues is economic slowdown, and the economic recovery may take some time. Thus, not much can be done, apart from higher incidence on existing tax base, for revenue enhancement. The deficit has to be reduced by bringing austerity in expenditure. The PTI government is vocal on austerity, but the numbers tell another story.

The consolidated current expenditure is up by 17 percent in the 1HFY19 and the growth is consistent with previous years, apart from the time when the government was in IMF programme. Not much can be done in curbing debt servicing growth (17% in 1HFY19] without having primary surplus. Similarly, the government has not much control on 21 percent growth in defecne expenditure.

Some serious efforts are warranted to curb other current expenditure which grew by whopping 23 percent in the 1HFY19. The finance ministry has to have a focus on bringing efficiencies in non-salaried current expenditure. At this time, the only avenue government is using to curb fiscal deficit is slashing development spending. The consolidated PSDP shrunk by 37 percent in the 1HFY19 to Rs328 billion. This is further slowing down the already crippling economic growth. Not an optimal strategy for creating employment.