Growing fiscal risks

Ministry of Finance has released the mid-term budget review report for 2019-20 and identified six major fiscal risks facing the economy: (i) substantial revenue shortfall; (ii) unexpected volatility in exchange rate; (iii) losses and circular debt in the energy sector; (iv) increase in pension expenditure and liabilities; (v) unexpected public debt and financing of fiscal deficit.

All six are major sources of concern and have been for decades but they have naturally assumed a critical aspect given that Pakistan is on an International Monetary Fund (IMF) programme which indicates the economic team leaders agreed to a time-bound performance criteria and structural benchmarks. The substantial revenue shortfall was projected as the original programme target was an unrealistic 5.5 trillion rupees (noted in the budget 2019-20), and revised downward to 5.23 trillion rupees in the first quarterly review documents uploaded on the IMF website. The Federal Board of Revenue (FBR) reportedly informed the IMF mission during its second quarterly review mission (3 to 14 February) that achieving 4.7 trillion tax target would be a challenge while the Fund team has insisted on 4.9 trillion rupees that would require 200 billion rupees of additional taxes till 30 June 2020 - economically unrealistic given the low growth rate with a high political cost for the government.

Losses and circular debt in the energy sector have not witnessed any appreciable decline through improved governance and the IMF's condition of achieving full cost recovery has, like during previous administrations, been largely met by raising tariffs, with cost implications for the manufacturing sector as well as households. This in turn will have repercussions on tax collections with political implications.

It is therefore little wonder that second review talks with the Fund have remained inconclusive so far with the government proposing that the decision to raise taxes and/or raise tariffs further must be deferred till after the budget for the next fiscal year. Advisor to the Prime Minister on Finance Dr Hafeez Sheikh's offer of a quid pro quo that he pledged during his National Assembly speech namely raising non-tax revenue by as much as 1500 billion rupees from the budget estimates (through privatization and higher State Bank of Pakistan profits) clearly requires further tweaking to convince the Fund.

The report notes an increase in pensions and liabilities and in this context this newspaper did highlight the fact that pensions (civilian and military) have risen rather dramatically in the current year - by 79 billion rupees from the revised estimates of last year and there is a need to identify the reason behind this unusual rise. Additionally, there is a need to revisit some other current expenditure given that the budgeted amount under this head rose by an unprecedented whopping 30 percent. Given that Ehsaas programme is subsumed under current expenditure it is relevant to note that it constitutes an insignificant amount of total current expenditure.

The report notes unexpected volatility in the exchange rate. Post staff level agreement on 12 May 2019, the rupee lost value yet it peaked on 1 July 2019 at 160 rupee to the dollar and by September it became more or less stable at between 155 and 156 rupees to the dollar. However, given that each rupee depreciation vis a vis the dollar adds 100 billion rupees to government debt the fallout of the market-based exchange rate on the government's finances has been considerable.

The report also maintained that the bulk of borrowing was from concessional bilateral and multilateral sources ignoring the fact that borrowing from commercial banks was 1.799 billion dollars during the first six months (budget envisaged borrowing only 2 billion dollars from this expensive short term source) - the highest-ever in the country's history. Analysts project borrowing from this source to be higher than the budgeted amount and in the event that a staff level agreement is not reached with the Fund for the second quarterly review soon this may be the only source left to tap.

The report harped on the major achievement of the government notably reducing the current account deficit by 75 percent and thence began to note statistics in percentage terms to reflect good performance without dwelling on the fact that import compression accounted for lower tax collections and lower output; exports grew by 4.5 percent but given that the base was very low it implied a couple of 100 million dollars increase - too little to maintain that the upturn has begun.

There are undoubtedly very serious challenges facing the country but the time bound range and depth of performance and structural benchmarks agreed with the IMF are simply too challenging and need to be tweaked to ensure that the programme is completed.