Whither the budget deficit

There was intense speculation on the government's ability to meet the budget deficit target of 7.2 percent for the current fiscal year, the same as projected for 2018-19, agreed with the International Monetary Fund (IMF) even before the rampage wrought on the country's fragile economy by the Coronavirus; today the projection maybe closer to 12 percent as opposed to between 9.5 to 10 percent forecast recently by the Moody's Investor Services and 9.2 percent pre-Covid19 projection by the IMF in documents titled Request for Purchase Under the Rapid Financing Instrument (RPI).

Data released by the government in August 2019 revealed that the budget deficit for 2018-19 was 8.9 percent and not 7.2 percent on which the 12 May 2019 IMF staff level agreement with Pakistan for a thirtynine-month Extended Fund Facility (EFF) was reached. The Fund's pre-Covid19 projection of 9.2 percent indicates that the budget deficit target was adjusted before the onset of the pandemic and is expected to be further adjusted as the actual impact of the Coronavirus is quantified. Be that as it may, the IMF's focus in its Extended Fund Facility (EFF) programme was on the primary as opposed to the budget or fiscal deficit and this is reflected in the Fund documents: "The forthcoming budget for FY2019/20 is a first critical step in the authorities' fiscal strategy. The budget will aim for a primary deficit of 0.6 percent of GDP supported by tax policy revenue mobilization measures to eliminate exemptions, curtail special treatments, and improve tax administration. This will be accompanied by prudent spending growth aimed at preserving essential development spending, scaling up the Benazir Income Support Program and improve targeted subsidies, with the goal of protecting the most vulnerable segments of society."

The first mandatory IMF review report gave the primary deficit at positive 0.6 percent - achieved due to higher revenue collections (sourced to raising existing taxes as opposed to widening the tax net) and lower disbursements than budgeted particularly with reference to only 8 percent release out of the total budgeted under the Public Sector Development Programme (PSDP) as opposed to 25 percent earmarked for the first quarter and less than one percent for social development due to the then ongoing process of updating/revamping the National Socio-Economic Registry as well as developing a data portal aimed at consolidating data from population-based surveys. The government committed to the Fund that in the second quarter it would ensure that disbursements under these two heads would reach the target levels set in the budget - a pledge that has since been largely honoured and with respect to BISP or cash disbursements to the poor and vulnerable the target may have exceeded the budgeted amount as per the government's corona relief package.

The latest report on the IMF website on Pakistan titled Request for purchase under the RPI notes a primary deficit of 0.7 percent pre-Covid19 and projects it at negative 2.9 percent of GDP in the current fiscal year (as per the Medium Term Macroeconomic Framework 2016/17-2024/25) due "to a 1.8 percentage point decline in tax revenue relative to the pre-virus baseline, and the needed higher spending to support the health response, social safety nets for the very poor and employment." The pre-virus baseline in the first mandatory review was 5.2 trillion rupees, downgraded from the original unrealistic baseline of 5.5 trillion rupees for the current year; reports indicate that there was a deadlock between the Fund and Pakistan during the second mandatory review with the former insisting on a further downgrade of the baseline to not more than 4.9 trillion rupees while the FBR was projecting a maximum tax collection of 4.63 trillion rupees for the year (as noted in the RFI documents). Post-Covid19 the FBR readjusted its collection target to 3.9 billion rupees. Hence it is unclear what the baseline was finally agreed that prompted the Fund to announce that the staff level agreement was reached on 27 February 2020 and since the second review report has yet to be submitted to the Board, a prerequisite for tranche release, because reportedly it contains pre-tranche release conditions which Pakistan had not met at the time (and is not expected to meet with the ongoing pandemic) the baseline or the structural benchmarks and quantitative time bound targets agreed, including the FBR target, are not known.

Additionally, the Fund's focus today is urging governments to deal with the fallout of the virus acknowledging that the "social and economic impacts is expected to be especially severe in the coming two quarters" or from now till end September adding that while the Pakistani government's response has been appropriate "but it must be temporary...and the authorities must decisively press ahead with the reforms included in the EFF as soon as the immediate crisis pressures subside."

The Fund appropriately acknowledges that "forecasts are subject to higher than usual uncertainty" and that "while uncertainty is high Pakistan's economy will be impacted through external and domestic channels." Externally, Pakistan's exports will decline due to the global downturn in our major export markets, more limited financial flows, and a sharp decline in remittances; and "domestically the impact of containment measures together with heightened uncertainty and generalized loss of confidence by business and consumers are likely to result in concurrent demand and supply shocks feeding off each other, with severe effects on investment and output....public finances are expected to come under significant pressure, and access to capital markets temporarily lost. This will give rise to urgent balance of payment needs of about 2 billion dollars (0.8percent of GDP) in Q4 FY 2020 that, if not addressed, could result in severe economic disruptions." The IMF projected negative 1.5 percent growth for the Pakistan economy in 2020 which would have repercussions on the primary as well as the budget deficit.

The budget deficit is expected to rise given the massive contraction of FBR revenue (1.6 trillion rupees lower than the original target of 5.5 trillion rupees) and the announcement of the 1.2 trillion rupee Corona relief package (though it is unclear how much, if any, of this amount is additional to the budget for example the 280 billion rupee included as wheat procurement is an annual government purchase with the money disbursed retrieved upon sale of the wheat, the 75 billion relief claimed under lower petroleum products is attributable to lower international price of oil). The 2 billion dollar loans from multilaterals to provide relief to those suffering from the pandemic are around 350 billion rupees, or only around 27 percent of the total package.

Thus while the primary deficit did not take account of the country's indebtedness and associated repayments as and when due (a condition that gave a reprieve to the Khan administration with respect to crippling borrowing during the period of the Dar-led Finance Ministry) yet with a lack of focus on the budget deficit the Fund has allowed for heavy borrowing during the programme period, estimated at 38.6 billion dollars during the programme duration according to the letter of intent submitted by Pakistan. The RFI document indicates that the gross external financing requirements for the current year are 25.36 billion dollars, (including bridging the current account deficit of 13.8 billion dollars, amortization of 11 billion dollars) while available financing is 23 billion dollars with official creditors extending 16.5 billion dollars (including multilaterals and China agreeing to a rollover of 2.6 billion dollars).

To conclude, one would hope that the government sets its budget deficit target conservatively which would require considerable tweaking of policies agreed in the EFF but particularly with respect to resisting upfront conditions and opting for a more phased approach aimed at not stifling economic activity as was the case during the pre-Covid19 programme implementation. However there is little comfort level in this regard as the economic team, in the letter seeking the RPI pledged that "we remain committed to the reforms included in the EFF and aim to press ahead with their decisive implementation as soon as the immediate pressures subside....once the current crisis has abated we will resume the fiscal consolidation envisaged in the EFF." On behalf of Pakistan the team also pledged that "since the funds obtained under this RFI will be used for budget financing, we will update the existing memorandum of understanding between the Ministry of Finance and the SBP on their respective responsibilities for servicing the related financial obligations to the IMF" - a document signed on behalf of the government and which therefore needs to be reviewed by the cabinet and made public in the spirit of transparency.