A fiscal quagmire?

A few days ago, Ministry of Finance released the details of fiscal operations covering three quarters Jul-Mar 2021-22. An examination of the data reveals a great deal of information regarding the direction of the economy. Accordingly, in this article, we would review the three-quarters fiscal results and make an attempt to project the final year outcome based on several factors including the past trends in recent years.

Let us first look at the budgetary estimates announced during the budget for FY-2022. The total federal budget deficit was estimated at Rs 3,990 billion. Furthermore, it was also provided that provinces would contribute a surplus of Rs.570 billion.

Thus the overall fiscal deficit (OFD) was estimated at Rs 3,420 billion. Given that the initial nominal GDP was estimated at Rs 53,867 billion, the federal deficit was 7.4% whereas the OFD was 6.3%. Subsequently, after the rebasing of the national accounts in early 2022, the new nominal GDP was assessed at Rs 63,978 billion. Accordingly, at the budget estimates, federal deficit and OFD were estimated at 6.2% and 5.3%, respectively.

It may be noted that it is the nominal deficit which is targeted under the International Monetary Fund (IMF) programme simply because it serves the purpose of austerity. Based on old GDP, in its Sixth Review report, the IMF had revised its estimate for deficit to 6.9% compared to 5.6% programmed at the time of the budget.

It may further be pointed out that last year (FY2021) the federal deficit and OFD were realized at Rs 3,541 billion and Rs 3,376 billion or 7.1% and 7.0%, respectively. Notice that FY2022 budget estimates stipulated slight improvement in fiscal numbers.

The above estimates would serve as the benchmarks for our analysis of budgetary performance. The Jul-Mar FY2022 fiscal operations reveal that the OFD was recorded at Rs 2,566 billion or 4% of GDP and federal deficit was Rs.3165 or 5%. Compared to this, for the same period last year OFD was Rs 1,652 billion or 3.5% of GDP and the federal deficit was Rs 2,065 billion or 4.5%.

Note the fact that the difference between OFD and federal deficit is the provincial surplus. Thus in both last year and in the present, the provincial deficit was nearly 1% of GDP, which is very significant. This shows the final fiscal outcome would be vulnerable to the actual size of the provincial surplus.

We identify the following risks to the final fiscal outcome based on the reasons stated therein.

First, the size of subsidies is clearly out of line with the budgeted target. The budget made a provision of Rs 682 billion. In the first nine months, an expenditure of Rs 575 billion has been recorded which is 84% of the budget.

There have been many heads of subsidies where significant overruns have been reported. Two of these heads are the subsidy to exports sector for LNG, which is guaranteed at $6.5 mmbtu compared to the actual procurement at $27 mmbtu and excessive accumulation of nearly Rs.500 billion in the power sector.

Second, the interest rate of 7% which was the basis for working out interest on domestic debt has risen since September and now stands at 12.25%, with T-bill rates rising to nearly 15%. For greater part of the fiscal year, interest rate was above 7%, the policy rate which was reached in June 21. One percent increase in average interest rate would contribute Rs.250 billion in debt service and thus lead to overrun in expenditure.

Third, the PM’s Relief Package announced by the previous government, freezing petroleum prices and reducing electricity price by 20% until June 2022, would have a major impact on the fiscal outcome. The previous government had estimated a cost of Rs.460 billion but the present finance minister has put it higher than Rs 750 billion.

The reasons for varying estimates is simply because of unknown future petroleum prices, which so far have been rising since the announcement of the package. Whatever the final cost, it would have a significant impact on budget overrun.

Fourth, the provincial surplus seems on track at least in the first three quarters. The real challenge is to maintain its momentum in the fourth quarter. The provinces also have the habit of making huge outlays in the fourth quarter. Last year, the surplus was Rs 410 billion in first three quarters and then dropped to Rs 313 billion in the fourth. When provinces would be asked to chip-in for subsidies their surplus would fall significantly.

Finally, even if we restrict our attention to historical pattern of deficit in the last quarter, we see a grim scenario. In the last three fiscal years, the average deficit incurred in the last quarter was 4.5%. This alone shows that the fiscal outcome would be significantly off the budget target.

At 8.5% the nominal deficit would Rs 5,440 billion much higher than IMF’s revised projection of Rs 3,761 billion at the time of Sixth Review. This is full Rs 2,000 billion above the budgeted level. This is close to Rs 5,600 billion which the new finance minister has stated in his many press conferences.

We have so far assumed that the new government would not significantly alter the economic scene in the next two months. This is a reality as the government has not touched the PM’s Relief Package but has added many of its own subsidies on flour and sugar. There is talk of more such subsidies in next few days which would make things more intractable on the fiscal side.

The fiscal policy is at the core of economic stability. With such a high fiscal deficit, it is inevitable to see a rising current account deficit also. Which in turn poses financing challenges as our reserves come under huge pressure as at present.

The reserves have fallen to $10.4 billion, which was nearly the level when PTI Government started its term. More importantly, the country should brace for higher inflation in the near future also. With so much over-spending, money supply would be excessive and would translate into higher prices even without imported inflation.

Copyright Business Recorder, 2022