Economy and the budget

The state of the economy of a country and its budget are always closely linked. If the indicators of an economy are sound, there is a room for expansionary fiscal stance and, in general, some concessions and incentives to the public can be offered.
Otherwise, the budget attempts to stabilise the economy by initiating policies aimed at correcting the emerging imbalances in the key areas. Judging by this criterion, the budget presented on June 5, 2006 for FY07 contains policies which are mostly hotchpotch and politically driven.
The Economic Survey unveiled a day earlier, ie on June 4, depicts the state of the economy in a very upbeat tone, as if Pakistan is going to join the list of developed countries in the near future, whereas the reality is that life of an ordinary citizen is going from bad to worse due to very poor law and order situation, increasing robberies, lack of drinking water supply and medical facilities, shortage of electricity, increase in prices and deteriorating standards of public sector education facilities.
Yet Pakistan's economy was estimated to grow by 6.6 percent during 2005-06 despite higher energy prices and unprecedented earthquake in the northern areas of the country. According to the Survey, three or four years of strong economic growth has positioned Pakistan as one of the fastest growing economies in the region.
While the population is increasing at a rate of 1.9 percent per annum, real per capita GDP grew by 4.7 percent. Per capita in dollar terms was up by 14.2 percent, reaching $847 during 2005-06. There was a sharp pick-up in overall investment which reached a new height of 20 percent of GDP and "most notably, private sector investment remained buoyant owing to a rare confluence of various positive developments in the economy." The real private consumption expenditure grew by 8.1 percent while the national savings as a percentage of GDP declined from 16.5 percent in the previous year to 16.4 percent.
Lately, there has been some abatement in price pressures. Increase in CPI was 8.0 percent during the first ten months of 2005-06 as against 9.3 percent in the corresponding period in 2004-05. But fiscal outcome which had improved a great deal in the past has worsened somewhat recently.
The primary balance (total revenues minus non-interest total expenditures) was in surplus from 2001-02 to 2003-04, but entered a deficit zone in 2004-05 but again estimated to be in the surplus during 2005-06. "Pakistan must not allow primary deficit to get entrenched," says the Survey.
The overall deficit that averaged nearly 7 percent of GDP in the 1990s declined to 3.3 percent in 2004-05 but went up again to Rs 327 billion or 4.2 percent of the GDP during 2005-06.
According to the Survey, about 0.4 percent of this budget deficit was due to the expenditures incurred on account of rehabilitation and reconstruction in the earthquake-affected areas but such reasoning does not make any difference so far as its implications in terms of bank borrowings, inflation etc are concerned. During 2006-07, fiscal deficit is targeted at Rs 373 billion (including earthquake related expenditures) or again 4.2 percent of the GDP.
Deficit in trade balance continued to widen despite sizeable export gains, on the back of Pakistan's strong domestic demand fuelling non-oil imports. The merchandise trade deficit stood at $8.62 billion during July-March 2006 as against $4.3 billion in the same period of the previous year, thereby showing a deterioration of over 100 percent.
Pakistan's current account balance slipped into the red in 2004-05 after posting surpluses for three consecutive years. During the first nine months of 2005-06, the current account deficit stood at $4.7 billion compared to $1.18 billion in the same period in the previous year.
A very encouraging picture of external debt has been given in the Survey, including the statement that "Pakistan's external debt and liabilities have declined by $2.4 billion in seven years - down from $38.9 billion at the end of the 1990s to $36.5 billion by end-March, 2006." Comparison with the position a year earlier, however, has probably been avoided due to the fact that it would have shown only a marginal decline of $0.1 billion in external indebtedness.
Although the government has tried to paint quite a rosy picture of the economy and soft-pedalled some of the issues in the Economic Survey, it was difficult to conceal the obvious shortcomings which could have serious repercussions on the economy.
The budget is mostly laced with political undertones without making any real effort to address the problem areas. Obviously, the present economic conditions and the policy objectives dictated that a sound basis be laid to sustain a growth rate between 6 to 8 percent in the medium term as envisaged by the government, balance in the external sector was to be restored, fiscal prudence was observed and inflation was to be contained to a tolerable limit of less than 5 percent.
Looking closely, however, it would appear that most of the budgetary measures like increase in the salaries and pensions and the Rozgar scheme would strengthen domestic demand and thus would be contrary to the objectives stated above.
The sustainability of growth momentum crucially depends on the level of investment and saving rate in the economy. It is true that, investment rate as a percentage of GDP has increased from 18.1 percent last year to 20 percent during 2005-06, but it is still inadequate to sustain the growth rate as envisaged by the economic managers of the country in the coming years.
Assuming an Incremental Capital Output Ratio (ICOR) of about 4 - the average for developing countries - the investment rate of 20 percent could sustain a growth rate of about 5 percent. For the economy to yield a growth rate between 6 and 8 percent, investment rate between 25 and 30 percent is required which does not seem to be possible in the near future. In fact, even the present rate of investment may be hard to sustain due to the declining trend in the domestic saving rate and increasing dependence on foreign savings which cannot be assured.
For instance, domestic savings as a percentage of GDP which stood at 18.1 percent in 2001-02 declined to only 14.4 percent during 2005-06. On the other hand, dependence on foreign savings to finance our development effort has increased tremendously during this period. Foreign savings financed 3.7 percent of investment during 2005-06 as against minus 1.9 percent during 2001-02, indicating a big change of 5.6 percent in the source of investment supply during a short period of time.
Obviously, such a huge reliance on foreign savings is neither desirable nor sustainable. If this source of financing dries up over time which is quite likely, the prospects of higher growth rate will recede, contrary to the claims of the government of maintaining or strengthening the grown momentum. Sadly, there is no policy thrust in the budget to boost investment through encouraging domestic savings and discouraging consumption.
The return on NSS have been increased somewhat but the average real rate of return on deposits would continue to be negative, providing stimulus to consumption, speculation and hoarding.
There is no particular fiscal philosophy behind the budget except to compensate the government employees and pensioners for the rise in inflation and provide some more incentives to agricultural sector. Budget deficit has increased despite utilising privatisation proceeds as a financing item.
The people of the country would be perfectly justified in asking the government how long it is going to manage its house through the sale proceeds of the 'family silver.' Also, everybody in the government was busy propagating a few months ago that billions of dollars have been committed by foreigners for rehabilitation and reconstruction in the earthquake-affected areas.
If this were actually the case, then there would have been probably no need to devote so much domestic resources from the budget for the purpose. Besides, the distortions like subsidies which took a long time and lot of effort to remove have been reintroduced and this will have long-term implications for the economy.
There are no worthwhile measures in the budget to promote exports. On the other hand, the import bill is likely to expand further, mostly driven by high domestic demand, rising world oil prices, domestic shortages, overvaluation of the exchange rate and rising fiscal deficit. The government has also made ample provision in the budget to maintain the imports of durable items within the reach of the upper middle classes, keep the prices of essential items within reasonable limits and encourage the import of machinery for sectors like agriculture.
It was obvious from the external sector developments during 2005-06 that the country needed to restore the balance in this vital sector in the coming years. Instead, all the policies in the budget point to the contrary which is rather unfortunate. The privatisation proceeds, issue of sukuk bonds, and receipts for services rendered can improve the current account but only temporarily.
The adhocism of policies is more than evident in the measures aimed at curbing the inflationary pressures in the economy. Instead of tackling the phenomenon head-on and removing the underlying causes of inflation, a crude effort has been made to cover up the problem.
Measures like subsidised supply of pulses and sugar at utility stores, setting up of special mandies in Islamabad, Karachi and Lahore and appointment of special magistrates to check prices could have been adopted in World War II but don't fit well in the condition this day and age. If such a trend continues, the days of rationing of essential items cannot be far off.
Somebody needs to tell the government that only a tiny minority of population can avail itself of the facilities of the utility stores and that too after standing in the queues for a long periods. Besides, such policies are generally counter-productive and would certainly bring into being the evil practice of black marketing.
The authors of the Survey, among other achievements, have claimed that poverty and unemployment in the country have declined a great deal. They believe that a strong growth in the economy, rise in per capita income, a large flow of remittances and massive spending on poverty-related and social sector programmes have made this possible.
While some movement towards the desired direction is quite likely, the extent of gains claimed in the Survey is sure to raise eyebrows and probably called in question. Percentage of population living below the poverty line is reported to have fallen from 34.5 percent in 2001 to 23.9 percent in 2004-05, a decline of 10.6 percent in a short period of four years.
In order to show that these figures were authentic and beyond any doubt, references have been made to the endorsement of World Bank, ADB, UNDP and a professor named Nanak Kakwani. However, it needs to be pointed out that the present poverty level in the country as given in the Survey is still very much above the global level and may not even indicate the true trend. On the basis of $1 a day, poverty on global level was 21 percent.
The methodology used in Pakistan is entirely different and based on 2350 calories per day or Rs 878 per month. If the international standard of $1 per day or Rs 1800 per month is adopted, the poverty level in Pakistan would be much higher and the trend, of course, cannot be known due to non-availability of figures on this basis.
Similar haziness shrouds the employment figures. According to the Survey, the unemployment rate which stood at 8.3 percent in 2001-02 came down to 7.7 percent in 2003-04 and declined further to 6.5 percent during July-December, 2005.
If natural unemployment rate of 3-4 percent is excluded, the economy seems to be almost at a stage of full employment, which is simply ridiculous to claim. At least on paper, there seems to be hardly any difference in the employment rate of Pakistan and developed countries where the signs of "help wanted" are always visible and the business of "head hunters" is booming. Advertise a job of a clerk in some office in Pakistan and thousands of more than qualified people would be seen desperately seeking this job with all kinds of recommendations from different sources.
The authors of the Survey would do a great service to the nation if they could adopt international standards and produce figures which are in keeping with the ground realities.
A great disservice which the various governments in Pakistan have done is the undermining of credibility of the official figures, causing a general state of alienation and apathy of the public towards government's claims. Political expediency seems to have taken precedence over everything else.
A few comments about some of the budget measures would also be in order. An increase in the salaries and pensions of the government servants, though badly needed, would give additional purchasing power to this class of employees which would be largely spent on essential commodities and dead to an increase in their prices, thus putting further burden on non-government employees and other ordinary citizens.
The raise in minimum wage from Rs 3000 to Rs 4000 per month would, at best, only apply to the workers in the formal sector. Such a narrow targeting is generally frustrating for mass of workers not covered under the budget proposals. Administrative measures to control prices as announced in the budget generally create artificial shortages and are never successful in the long run.
The Rozgar scheme is almost certain to meet the fate of populist schemes designed in the past like yellow cabs and green tractors. These kind of schemes could win the voters but usually end in failures.
The government has decided to use the banks as a major tool for tax collection. Five percent duty on a number of services provided by the banks would encourage cash transactions, defeat the documentation objective and would add to the already heavy cost of doing business in Pakistan.
The State Bank should have argued against these measures. Although tax on real estate business was justified, it would have been better to propose a lower tax rate in order to induce the buyers/sellers to declare the true value of the property.
It would have been even better to tax the profits rather than the value of the property. Imposing tax at the rate of five percent on the rental income will hardly yield any dividend if it is not accompanied by a rigorous effort to bring the property owners under the tax net.
No measures have even been mentioned to tax the rich landlords. Probably the provincial governments will also not dare to touch this class due to its clout. All of this does not mean that the Budget does not contain any positive proposals. These have been omitted in order to highlight the other side of the picture.