Fiscal slippages require monetary adjustments: Dr Shamshad Akhtar speaks on Budget-I

This is the first budget I am associated with in the Government and by all stretch of imagination it is a very interesting budget. It has a combination of what I call the softer face to it but at the same time it tries to retain the spirit of fiscal prudence and stability so in that sense I find it an interesting blend.
What is impressive about this budget is that it very caring pro-poor and relief-oriented budget at a time when this is clearly a social concerned regarding the price stability question but also regarding the people have been concern about their living standard and incomes, so it tries to combine all the faces in a very effective way while as I have said maintaining the overall fiscal stability directions to a larger extent.
So I am very upbeat about it, and I think it's a budget which is full of several elements, a few key features which I like to definitely highlight which are pretty striking.
One is that we have fiscal deficit increment there of about 0.3% of GDP relative to last year, so there is no doubt that the core deficit excluding the earthquake is somewhat higher than last year. But this 0.3% increment is achieved while accommodating a lot of interesting dimensions.
First of all these have been an unprecedented increase in this development expenditure for both the federal Government and provinces. It has been achieved by expanding the provincial share in the resources, which is again a major and steep increase, it involves a fairly decent program of relief measures and subsidies, which touches virtually every segment of common man starting from salary class to non-salaried and also it tries to en-cash upon the existing trend of restrains on current expenditure on taxation side as you may have noticed what is interesting is that the Government is aiming to have higher growth in the taxes and the percentage increase in the tax revenue is going to be above the nominal GDP increase.
So this is going to be inheritantly higher buoyancy captured of the taxes also it has new revenue measures about 0.3% of GDP or about Rs 25 billion which is partly offset by relief measures.
I read S&P report very quickly while coming to this place, and I think there is a misunderstanding I see in the figures that they have quoted. Let me first acknowledge and as I have said upfront that there is no doubt that you exclude the earthquake part, which should be set aside because it's an exogenous event hit as and we have to accommodated its expense but if you look at the core deficit excluding the earthquake you do find that there is an increase of 0.3% and it has been accommodate while we are expending massively the development expenditure for the right reason it is very important for us to increase our development expenditure because our GDP/ Investment ratio is very low and it has been on a declining trend, so we have to reserve that and for that we will have to increase public investment and for that if a slight increase in fiscal deficit of manageable increase then we will have to live with it.
Now where the confusion arises I need to clarify it also with S&P, in our Fiscal Responsibility Act it was clearly mentioned that the Government needs to ultimately reach revenue surplus, so if you see the underline factors of this 3.7% of GDP fiscal deficit the revenue deficit is actually positive and you have a primary surplus or 1.4 or 1.5 percent, besides the revenue deficit has also been reversed now we have revenue surplus.
I judge the direction of the fiscal policy in a combined way. I don't look just our number, I look at what are the underline qualitative dimensions of this budget, and of course fiscal deficit/ GDP is very critical. It has to be on a down trend and it is regrettable that it has increased but the compulsions are currently such that we need to raise our development expenditure and in order to accommodate the development expenditure our fiscal deficit has increased.
SUBSIDY: First we discuss the qualitative aspect of budget and as I have tried to point out while fiscal deficit/GDP ratio may not have declined in a persistent way and there is a little reversal in course, qualitatively it is an interesting and important budget, because we have increased development expenditure in GDP.
So, if you consider the underlined factors there has been a massive increase in the social expenditure in fact bulk of the increase in the development expenditure goes into areas, one on increase in social expenditures and two in the increase in the infrastructure expenditure and these are not only growth-oriented element of the development expenditure but they are also trying to support the social uplift programs.
It deals with education, health, poverty alleviation and off course on the sideline we have relief measure for the poor. So I think qualitatively it as a very rich and interesting budget.
Whether it will get our fiscal sustainability a question. I think the only point I would like to submit here that both the Government and all the players with the government have to make sure that going forward we don't let the fiscal discipline drift at all. So, I think right now we are managing with a fair degree of fiscal prudence but we should not indulge in excessive spending, which will take us away from our prudence, that is very critical.
5% EXCISE DUTY ON BANKING SERVICES, WHY SHE ACCEPTED? It was very long debated that our tax base is fairly narrow in Pakistan and there is a need for Pakistanis to start looking beyond trying to tax same base again and again.
So, when the question came up, how do you broaden the tax base, one is of course to bring under net a lot of people who are outside the net of taxation system and among other things, it so happens that the financial services industry along with agricultural sector and a few other areas are either under tax or they outside the band of tax, so I think what is critical for Pakistan's fiscal sustainability is the need to tap all the avenues of taxations system and it so happens that financial services are one area which has not been effectively tapped. Services sector have to be taxed.
All the services sectors should be taxed and ultimately should be taxing the services of lawyers, doctors and so forth. In every country you have taxes on services sector, so financial services seem to be a much more amicable sector to be tapped.
As the nature of the tax which is acceptable or not, there were two options we had, either we have to tax transactions or we tax the services of financial sectors, and I personally believe, taxing the transaction is not a very healthy way of taxing the financial sector and in relative terms it's better to tax the fees and services by the non fund sources, so that how this taxation is designed, its not aiming to tax the transaction; we are not taxing the loans, which are more amicable to pass on to borrow but we are taxing the services fee, of the services like bill of exchange letter of credit and so on.
It is a different type of taxation that I am talking about and I can assure you every where else it has been done in the world, I mean, I have just come from the Philippines and out there all services are taxed. So Pakistan is not an unusual country.
INFLATION: First of all we have to recognise that the inflation rate in any country is not just decided by target given to the central bank. It has to be a combined effort of both Government and central bank, because price stability is an important goal of the central bank, but obviously, we know in Pakistan the Government plays an important role in signalling this area.
Now the fact that we have 6.5% target is something that I have agreed to not because it is achievable or not achievable. I have agreed to it because it is needed in Pakistan.
You know no matter wherever you go within the city everybody turns around and tells me we need to lower the inflation. So my acceptance of 6.5% is a challenge, which is a very difficult challenge.
I acknowledge, but if something I feel public wishes to move forward with, whether we succeed in it or not would depend at the end of the day on two factors principally and I think you have to understand that are all operate on the basis of assumptions and events they evolve and two major assumptions are real sector performance should be along the line we have projected if the GDP grows by 7% and underline growth in agriculture and industrial industry is line with what has been projected then we will be OK.
Why because then there will be adequate availability of agricultural and industrial products in the market not to have shortage not to have inflationary pressure because after all 40% of our CPI constitutes food.
The bottom line is if our real growth is performing in line with our expectations and productive sector are moving OK, then it means there won't be shortages in the system and as long as we don't have shortages in the system we want to have what I called the food price inflation.
Now the second dimension is within the domain of the Central bank but again we are not the only... I mean we inherit the impact, we can't tackle the problem unless we attack the source of problem and the second component we call core inflation, which excludes all the volatile components, food and energy, how do we control that, we are.
OIL PRICE: Oil price is a global phenomenon and I can tell you through implicit and explicit measure, we are attempting not to pass the full burden of oil prices. Central bank involvement in this regard is to the extent that it provides the foreign exchange up front to really finance the oil imports and that it has a very positive impact, because we don't stir the market but letting the payments crowed out at the end of the day.
So it has a positive impact of its own kind both on foreign exchange availability and all that. But coming back to my other point which you asked about the challenge given to central bank and I think you need to understand because the central bank is accountable to that.
First, I mentioned it is linked with growth rate and second point is that fiscal deficit and its financing has to be in line, what has been projected in the budget and this is very important to understand the reason being, first of all the fiscal deficit is above last year level and secondly its financing, it has to be in accordance with the desired that we have currently and slippage then it will create problems for us in controlling inflation and I can explain this point with little bit some of the arithmetic here.
Budget has announced 140 billion, but actually it's 120 billion borrowing which excludes the operational shortfall, so government as expected, it will borrow from central bank up to 120 billion.
How does it estimate that number? It is assuming higher flows from external financing or it is also expecting that the fiscal deficit will be contained and the recurrent expenditure will be contained. If all these realise, in the external financing we are assuming that official development assistance program funding, quick disbursing will be there.
We are also assuming GDRs follow of $1 billion, another 500 million from dollar or euro bond issue, then we are assuming privatisation proceed from a certain level. Now privatisation proceeds we are assuming about Rs 75 billion.
I personally think it's fairly cautious figure because we have a huge privatisation mandate, but we are careful to include only those privatisation elements, which are possible, but program lending from multilateral development banks of the desire level, raising resources from FDI outside the privatisation dimension, these are important challenges we face.
We will be able to curb the pressure on the central bank financing only if materialised the financing that are have planned for. Coming back to sequences, our experience of outgoing year, it has been a little checker, in many ways, because during the year had tremendous amount of pressure on the bank borrowing but at the end of the day interestingly the government level of borrowing from central bank in net term is lower then original targets.
But what happens that during the year when they are borrowing and graphically it is a steep then the problems arise that our reserve money growth becomes very high on an in term basis and when this happens obviously inflationary pressure on month to month basis become higher.
TIMING OF INFLOWS: This is unfortunately disconnected between when you have resources available based on your planning and when you have to spend the money. There will always be a situation of timing discrepancies but this is not a deliberate policy of the government, and I wouldn't even call it fiscal mismanagement. It is just that spending occurs in accordance with the requirements only if we accelerate privatisation upfront.
Then the experience that we had this year will not repeat and I am quite confident, having been associated in some of privatisation debates, as you know the governor is also a member of cabinet committee on privatisation that I feel some speed work has been done for the privatisation of PPL and PSO, which are the two principal items in the privatisation process. If we sell quickly and if we line up other recourses early, within the first half of the fiscal year then it will not happen again which happened this year.