Imperatives for FY23 budget

The federal budget for 2022-23 is to be presented by the coalition government on the 10th of June in the National Assembly. This budget has special significance for several reasons.

First, it needs to take into account the incipient financial crisis that the country faces today with foreign exchange reserves down to $9.7 billion, barely enough to provide import cover for one and a half months.

Therefore, the budget will have to be contractionary in character such that the level of aggregate demand in the economy is restricted to limit the size of the current account deficit in the balance of payments.

Second, the budgetary targets will have to be cognizant of the fiscal targets for 2022-23 agreed with the International Monetary Fund (IMF) in the sixth review of the Programme.

However, it is hoped that in the on-going discussions with the IMF Staff Mission the government’s economic team will be able to get appropriate changes in the targets in light of the recent big negative developments in the global economy, especially after the onset of the Russia-Ukraine war.

They have led to a quantum jump in global commodity prices and to higher interest rates as efforts are made by developed countries to tackle the growing inflationary pressures.

The changes to the original targets for the 2022-23 budget must include more fiscal space in the form of a larger deficit due to the likely less growth in tax revenues due to efforts at restraining the level of imports, higher costs of debt servicing because of the rise in interest rates and the need for larger subsidies to protect the lower income groups from the ravages of much higher inflation.

Third, the emphasis in the federal budget should be to ensure a strong process of income redistribution in the economy. The people must get the perception that the higher prices they are having to pay for petroleum products, electricity, and gas, will be balanced by strong and wide-ranging relief measures for them that will be adequate to prevent a rise in the incidence of poverty in Pakistan.

The cost of these relief measures must be borne by the wealthy and upper income households in the country through strong measures of progressive direct taxation.

An agreement with the IMF is essential for revival of the Extended Fund Facility. This is necessary not only for the inflow of the remaining $3 billion in the programme but also to improve perceptions of the credit worthiness of Pakistan and lead to larger inflows from multilateral agencies and bilaterals. Also, large roll-overs of debt will become feasible only in the presence of a functional Fund programme.

The targets agreed with the IMF for 2022-23 were based on the outcome in 2021-22 of budget deficit of 6.3 percent of the GDP, with the GDP being measured with 2005-06 as the base year. The base year has now been changed to 2015-16 by the Pakistan Bureau of Statistics. With the over 16 percent larger GDP, the expectation is of a deficit of 5.4 percent of the GDP this year, with the base year of 2015-16.

The likely outcome is a visibly larger deficit of almost 7.8 percent of the GDP. This spillover is due, first, to lower revenues from the petroleum levy (PL) and the sales tax on petroleum products which were effectively withdrawn by the previous government on the 28th of February when petroleum prices were reduced by Rs 10 per liter.

Second, the rise in interest rates has increased the cost of debt servicing by over Rs 300 billion. Subsidies to the power sector have been higher to limit the growth in the circular debt. Also, the subsidy on petroleum products from March onwards will add almost Rs 350 billion to current expenditure. To finance these subsidies, the federal PSDP (Public Sector Development Programme) has been reduced by almost Rs 400 billion. Overall, the federal budget deficit is likely to be over Rs 1500 billion larger than originally anticipated.

Faced with this outcome, the original target of the budget deficit for 2022-23 of 3.9 percent of the GDP looks well beyond the realm of possibilities. It will require a halving of the deficit from 7.8 percent of the GDP this year.

As such, there is need for negotiation with the IMF on a larger deficit target for 2022-23. The recommended approach is to strive for the required reduction over a two-year period. As such, the recommended size of the budget deficit in 2022-23 is 5.9 percent of the GDP.

The target for FBR revenues set with the IMF for 2022-23 is Rs 7255 billion. This is infeasible if the sales tax and PL continue to remain withdrawn. There is a case for restoration of the sales tax but with the international crude oil price high at almost $120 per barrel there is no scope for the imposition of the petroleum levy. As such, a FBR revenue target of Rs 6900 billion looks more feasible. It will require new taxation of almost Rs 650 billion in the forthcoming budget.

Some of the more progressive taxation proposals for creating the perception of a ‘sacrifice’ by the upper income households at this difficult time in the country are as follows:

i) Reintroduction of the wealth tax in the form of the capital value tax at 1 percent initially on properties, shares, and motor vehicles.

ii) Reduction in the number of slabs in the personal income tax from 11 to 6, with the maximum rate applicable on income of Rs 25 million as compared to Rs 75 million currently.

iii) Higher rates of withholding taxes on imports, services, large commercial and domestic electricity bills, transactions in shares and on dividends.

iv) Minimum rental income taxation on commercial properties based on the FBR valuation of properties at the neighborhood level.

v) Taxation of real capital gains on sale of properties and shares irrespective of the holding period

vi) Strong pressure on the provincial governments to raise revenues from the agricultural income tax and the urban immoveable property tax.

Larger and more comprehensive relief measures for low-income households will need to be announced in the budget. Already, to compensate for the big jump in petroleum prices, the Government has announced a cash transfer of Rs 2000 per month for 14 million beneficiaries.

The annual cost of the package will be Rs 336 billion in 2022-23. The existing BISP allocation of Rs 246 billion will have to be retained. In addition, it is suggested that a special provision be made for lower food prices at USC outlets of Rs 50 billion and for Rs 50 billion to PASSCO for lower wheat price to flour mills than the procurement price to farmers.

The total relief package in the 2022-23 budget will be close to Rs 700 billion, close to the additional revenues to be generated from the above taxation proposals. The relief package will be almost thrice the allocation in 2021-22 and help in creating the perception that special efforts are being made to provide relief to the lower income households at a time when the rate of inflation will be high double-digit in 2022-23.

Finally, there will be need for strong economy measures in the federal budget, including no increase in pay or allowances. The access to free petrol be limited. No vacancies to be filled. The pensionable age to be raised to 63 years.

Privatization should take place of some loss-making state enterprises. Development allocations in the federal PSDP to be made only to mature trunk infrastructure on-going projects and the size restricted to Rs 600 billion. The four provincial governments must generate a cash surplus of Rs 750 billion, 32 percent above the likely level this year.

We hope that the federal budget deficit for 2022-23 can be agreed with the IMF at an appropriate level as suggested above which achieves significant fiscal consolidation but is politically and economically feasible. The economy can then begin to achieve financial stability along with a degree of redistribution.

Copyright Business Recorder, 2022