Stresses on the federation

The public eye has been focused on the on-going confrontation between the federal government of the PDM and the PTI–PML(Q) provincial government in Punjab on the issue of dissolution of the Provincial Assembly, so as to accelerate the process of holding of the national elections. It is now reached the stage where judicial intervention has taken place.

However, underlying the political tension there are also now financial stresses on the federation arising from a growing breakdown in the inter-governmental fiscal relations between the federal and provincial governments. This is mostly visibly manifest in the magnitude and timing of transfers from the federal government to provincial governments.

The first problem arose at the start of this year when it was announced in the federal budget for 2022-23 that the sales tax on petroleum products is to be replaced by the petroleum levy. The former is part of the federal divisible pool of taxes to be shared with the provincial governments as per the NFC award, whereas petroleum levy has been classified as a non-tax revenue source and, therefore, not to be shared with the provincial governments. This implies that the transfers to be made to the provincial governments will be lower by almost Rs 480 billion in 2022-23 and more thereafter. This implies a reduction in transfers of almost 15%.

Despite this contraction in the federal divisible pool, the federal government has agreed with the IMF, as part of the on-going programme, on very ambitious targets on the fiscal performance in 2022-23 by the four provincial governments combined.

They are expected to show the highest ever growth rate in own-tax and non-tax revenues of over 35%. Simultaneously, the growth in current expenditure is to be restricted to only 9% and that on development expenditure to only 3%. With this exceptional increase in revenues and economy in expenditure, the four provincial governments are expected to produce a cash surplus of Rs 750 billion, over double the actual level of 2021-22. This surplus will contribute 16% to the reduction in the consolidated budget deficit of the federal and provincial governments combined.

However, something unusual has happened. Based on actual revenues of the federal government in the first quarter 2022-23, the NFC transfers should have been close to Rs 968 billion, incorporating the growth in federal tax revenues of 15% and straight transfers. Instead, the actual transfer in the quarter was Rs 880 billion, implying a shortfall of Rs 88 billion. The federal government has reduced the transfers so as to show a lower fiscal deficit in the quarter.

There is also evidence of discriminatory treatment by the federal government in transfers to the four provincial governments in the first quarter of 2022-23 as shown below in Table 1. The only provincial government which has seen a contraction in transfers is the Khyber-Pakhtunkhwa government. It is not surprising that this government is apparently having difficulty in making salary payments.

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                                     Table 1
                  Total Transfer* by the Federal Government to
                    each Provincial Government, First Quarter
                                                             (Rs in Billion)
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                           2021-22           2022-23             Growth Rate
                                                                         (%)
============================================================================
Punjab                         407               426                     4.7
Sindh                          218               222                     1.8
Khyber-Pakhtunkhwa             207               134                   -35.3
Balochistan                     77                88                    14.2
============================================================================
Total                          909               870                    -4.3
============================================================================
Source: Ministry of Finance, Fiscal Operations. *NFC transfer +grants +loans
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Consequently, with a decline in total transfers, and an absolute fall in transfers to Khyber-Pakhtunkhwa, the cash surplus generated by the four provincial governments in the first quarter is Rs 218 billion, which is 21% less than the surplus generated in the first quarter of 2021-22. At this rate, the annual cash surplus is unlikely to exceed Rs 350 billion in 2022-23. This will be Rs 400 billion lower than the target. Inevitably, the IMF will ask for this shortfall to be covered somehow.

There is another factor which is contributing to the lack of generation of an adequate cash surplus by the four provincial governments. This is the splurge in spending by the Government of Punjab, which historically contributes almost two-thirds to the total provincial cash surplus. This share has fallen to 57%.

Unlike the other three provinces, Punjab has shown a decline in its cash surplus in the first quarter of 2022-23 of over 31%. This is the impact of increase of 24% in spending by the government of Punjab during the quarter as compared to a decline of 3% in expenditure by the other three governments.

Over the medium-term there are other important issues in inter-governmental fiscal relations in Pakistan. First, the 7th NFC Award should have come to an end in 2014-15, but in the absence of a new Award it continues to be operative. The 8th and 9th NFCs failed to arrive at a consensus on a new Award. The 10th NFC has been notified but has made little progress.

Second, even after twelve years the 18th Amendment has not been fully implemented with respect to the devolution of functions. Higher education and population planning continue to remain in the federal domain. Third, there is need for harmonization of the federal sales tax on goods with the provincial sales tax on services. This is part of the reform agenda agreed with the IMF as part of the ongoing programme, but little progress has been made.

Overall, there is need for strict adherence to the constitutional provisions in the context of inter-governmental fiscal relations. This will play a vital role in strengthening the federation of Pakistan.

Copyright Business Recorder, 2023