The new finance team

Finally, a new Finance Team has been put in place. Congratulations are due to Dr Miftah Ismail for his appointment as the Adviser to the Prime Minister, with the status of Federal Minister, and to Rana Mohammad Afzal Khan, as Minister of State, both for Finance and Economic Affairs. It appears that the functions of Finance Minister will continue to be performed by the Prime Minister. Also, the responsibility of overseeing FBR will rest with the Special Assistant to the Prime Minister, Haroon Akhtar Khan.
The new team represents a strong combination of technocrats like Dr Ismail and Haroon Akhtar and a seasoned Parliamentarian like Rana Afzal. This will augment the capacity of one of the most important Ministries in the Federal Government. However, it will be important to ensure clear allocation of functions and proper arrangements for coordination.
The two new members of the Finance Team have revealed their priorities for the remaining five months of the PML (N) government. Apparently, Dr Ismail has been instructed by the Prime Minister to lower individual tax rates, widen the tax net, come up with a scheme to repay the refunds, reform certain corporate taxes that are adversely affecting capital formation and also study the possibility of allowing Pakistanis to bring their undocumented wealth into the country's economy.
Dr Ismail also says that efforts will continue to lower the budget deficit, the current account deficit and boost the foreign exchange reserves. Rana Afzal has also stated that efforts will be made to tackle four challenges, namely, the trade imbalance, fiscal deficit, depleting foreign exchange reserves and inflation. Also, he has emphasized on the timely completion of ongoing projects.
Needless to say, the Finance Team must recognize that the achievement of the stated objectives is the combined responsibility of a number of Ministries and the SBP. The Ministry of Commerce must be given enough policy space to take appropriate steps to manage the burgeoning trade deficit. Also, the autonomy of the SBP should be fully respected in the conduct of monetary and exchange rate policies. Monitoring the execution of projects rests with the Planning Commission. Of course, fiscal policy lies in the domain of the Ministry of Finance. It appears that tax policy and functions of the Revenue Division will now be with Haroon Akhtar Khan.
The new Finance Team has effectively been put in place at the end of the first half of the ongoing financial year, 2017-18. It will be worthwhile to review where the economy stands at this point. No doubt, there are some positive signs. The large-scale manufacturing sector has shown a very high growth rate of almost 10 percent in the first four months. Industries which have demonstrated exceptional buoyancy are food, beverages and tobacco; petroleum products; cement; automobiles and iron and steel products. Exports have also started growing once again, although much less than imports.
However, the industrial growth rate may be affected in coming months by the delayed start to crushing of sugarcane by the mills; sharp fall in output of furnace oil by domestic refineries and large imports of fertilizer and iron and steel products. Further, the largest industry, textiles has shown little growth despite growth in exports of 8 percent up to October 2017.
The initial expectations about output of major crops in 2017-18 were positive after the agricultural relief package. However, the latest estimates are that the increase in the size of the cotton crop is smaller than anticipated. Also, the forthcoming wheat crop could be severely affected by the big water shortage in Rabi season. These risk factors indicate that the GDP growth target of 6 percent may remain elusive.
The other good news is that the rate of inflation has remained low at close to 4 percent. However, although still low, the weekly SPI has been rising since end-October. Following the depreciation of the rupee by 5 percent recently, there is likelihood of a jump in the CPI inflation rate to between 5 to 6 percent, from about 4 percent currently. This will depend, of course, on what happens in particular to POL prices and electricity tariffs. Oil prices have risen by almost 30 percent since June 2017. This is bound to affect the domestic prices with a time lag. Will the Government, for example, opt to reduce significantly energy-related taxes to absorb the shock?
The worrying developments relate to the ballooning of the current account deficit and the increasing likelihood of the fiscal deficit target for 2016-17 being exceeded significantly. The former deficit has already crossed $6.6 billion in the first five months and may be well on the way to reach the record level of $16 billion or more in 2016-17. Will the new Finance Team follow the same policy to borrow more and more on costly terms to close the financing gap and prevent large erosion of reserves or will it come up with ingenious and well-crafted moves in the next few days or weeks to reduce the trade deficit and thereby the current account deficit?
The fiscal deficit has probably approached by mid-December the magnitude of Rs 800 billion. Domestic bank borrowing to finance the deficit stands at Rs 389 billion, equivalent to 1.1 percent of the projected GDP for 2017-18. Inclusive of the receipt of funds from flotation of bonds of $2.5 billion, net external borrowing has already exceeded Rs 358 billion or over 1 percent of the GDP. With non-bank borrowing included the overall consolidated fiscal deficit has probably crossed 2.2 percent of the GDP. At this rate and given the seasonality in the fiscal deficit, with the largest gap in the last quarter, there is a high likelihood that it will exceed 5.5 percent of the GDP by the end of 2017-18, substantially above the target of 4.1 percent of the GDP.
Here again, the question is whether the new team will propose major expenditure cuts or enhancement in tax rates to contain the deficits or hold back of transfers due to Provincial Governments to artificially contain the Federal deficit.. FBR revenue growth is also beginning to slacken and if full payment of refunds is made then net FBR revenues will show even less increase. In an election year, it is unlikely that the new team will be in a position to implement tough measures to cap the deficit.
The real challenge is the prevention of further decline in foreign exchange reserves. Already, SBP has taken the completely unacceptable step of dipping into the Foreign Currency Accounts by as much as $6 billion. This money must be returned to the commercial banks. There are also indications that the Government will float more bonds? Here again, it will be seen with interest the measures that will be recommended by the new team to sustain the reserves position.
Overall, we welcome the members of new Finance Team and pray for their success in the larger interest of the country. Their performance will be judged by whether they can go beyond a simple 'holding operation' up to the next elections or take major steps which will improve the economic situation and enable the next Government to start without an imminent crisis in its hands.
(The writer is Professor Emeritus and former Federal Minister)