Growth nabbed by current expenditures

After being contained in the second quarter, the revenue-expenditure gap rose back to 1.5 percent of the GDP in the quarter, ending March 2010.
With no significant change in the revenue stream, the governments domestic debt servicing and higher defence related spending was the main culprit. Even more worrisome is the higher reliance of deficit financing on domestic non-banking sources, which is visibly crowding out the already squeezed private sector.
According to the fiscal operations summary released by MoF earlier this week, budget deficit soared to 4.2 percent of GDP or Rs626 billion for the first nine months of this fiscal year, as against 3.1 percent of GDP in the corresponding period last year.
It would be a daunting task for fiscal managers to contain the deficit below 5.5 percent of GDP for the full year. Mind you, the budgeted target was 4.9 percent, which was later revised to 5-5.5 percent by SBP, in its half yearly report.
Reportedly, the revenue department collected Rs1,127 billion as federal taxes during the first eleven months, which is marginally lower (5%) than its initial target, but 16 percent higher than last year. The growth can be attributed to a slight economic recovery and accounting for Petroleum Levy (PL) in taxes.
Barring this PL, the growth in nine-month tax revenues was restricted to a hike in consumer price index. Also, the tax mix tilted further towards the regressive indirect taxes (by 250 bps to 66.3 percent), which is not a good omen for a country with high income disparity. The advent of VAT in FY11, if implemented, would worsen that ratio.
Amongst non-tax revenues, the government continued to rely on dividends from public sector entities and profits transferred from the central bank. Although, profits from the central bank rose 35 percent year-on-year, during the third quarter transfers thinned to Rs48 billion against the average of Rs68 billion in preceding two quarters.
Current expenditure during the nine-month period stood at Rs1,223 billion (8.1% of GDP), about 18 percent higher than the corresponding period last year.
Increased spending on defence affairs and services, because of war on terror, in the third quarter (Rs104 billion in Jan-Mar versus average of Rs83 billion in the previous two quarters) and soaring domestic debt servicing has left little for development purposes.
Although, PSDP spending in the third quarter rose 26 percent over the average of preceding two quarters, and 33 percent higher over the same period last year, at this rate it is still 12 percent short of the annual target.
Spending on development is a step in the right direction, but the government ought to critically look at its financing mix.
The scarcity of foreign funding is crowding out the domestic investment. With net external outflows of Rs18 billion, fiscal managers raised Rs240 billion (previous two quarters average: Rs147 billion) from domestic sources during Jan-Mar period.
In effect, fewer resources will be left for private credit - hampering the revival of the industrial sector and in turn the growth of services sector. With virtually no tax revenues from the consistently performing agricultural sector, tax revenues are likely to miss the target by even bigger margins, in the coming quarters. This threatens to create a vicious cycle of lower output and higher government borrowing.

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FISCAL POSITION

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PKR (bn)                    9MFY10   % of GDP   9MFY09   Diff (%)

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Revenues

Total Revenue                 1402      9.3%     1301        7.7%

Tax Revenue                   1015      6.7%     1205      -15.8%

Direct Taxes                   342      2.3%      308

Non-tax Revenue                387      2.6%      452      -14.4%

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Expenditure

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Total Expenditure (Booked)    2024      13.5%    1662       21.8%

Current Expenditure           1660      11.0%    1416       17.3%

Federal                       1223       8.1%    1038       17.8%

Servicing of Domestic Debt     429       2.8%     395        8.5%

Defence Affairs and Service    270       1.8%     224       20.4%

Development Expenditure        347       2.3%     243       42.9%

PSDP                           286       1.9%     216       32.6%

Budget Balance                -626       4.2%    -405       54.5%

Net External Inflow             93       0.6%      84       10.3%

Net Internal Inflow            533       3.5%     321         66%

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