FISCAL REVIEW 2011 - Federal budget FY12: unpleasant arithmetic

Budget deficit is the most heavily quoted number in the discussions of fiscal policy where different groups of economists consider different implications of budget deficit. The proponents of deficit argue that it provides fiscal stimulus to growth. According to them, budget deficit implies lower taxes compared to government spending, which causes an increase in aggregate demand that may lead to higher GDP growth and inflation.
For them, such expansionary fiscal policies need to be corrected by increasing taxes and lowering expenditure during the period of high growth in order to avoid negative repercussions of an overheated economy. In contrast, supporters of stabilisation policies emphasise that high budget deficit soaks up private savings and leaves too little for domestic investment. Simultaneously, it puts pressure on the monetary policy that causes both crowding out of domestic resources from the private sector and higher growth in monetary aggregates.
Where does Pakistan's case fit in this debate is perhaps a secondary subject, considering that the correctness of the official budget deficit numbers are questionable in itself. When the government exceeded its initial FY11 budget deficit target of 4 percent agreed with the IMF, it justified the deviation on the grounds of the massive floods of July 2010.
Authorities clarified that the flood resulted in a slowdown of economic activities and hence affected not only the sources of revenues but also put additional pressure on expenditures. This article analyses whether this deviation is a one-time phenomenon or an outcome of flawed assumptions usually made during the annual budget-making exercise.
Conceptually, the budget deficit is simply a difference between total revenues and total expenditure. The former includes both tax and non-tax revenues and the latter includes both current and development expenditures.
In reality, the computation of the budget deficit is slightly more complicated due to allocations made for the repayment of foreign debt, different tiers of governments, lending to autonomous bodies and so on. The table here indicates that current expenditures are expected to grow by only 0.8 percent in 2011-12 compared to revised estimates of 2010-11. Moreover, net current expenditure, after excluding repayment of foreign debt, indicates a decline of more than 4 percent.
Apparently, this decline is commendable and can be attributed to successful implementation of the 18th Amendment, which transferred the expenditure of 18 ministries and departments to provinces. However, an analysis of the trend in current expenditures and deeper screening of the provincial and federal budget documents indicate that this decline is difficult to materialise. The revised estimates of the current expenditures for 2011-12 would likely to be higher than the budgeted estimates.
In contrast to current expenditure, development expenditure (federal PSDP) shows a phenomenal growth of over 70 percent compared to revised estimates of 2010-11. Given low economic activity, this increase may have a multiplier impact and cause a boost in economic activities, if materialised. The historical trend in development expenditures indicates that any shortfall in resources or efforts to reduce the budget deficit has generally resulted in a downward revision of development expenditures. A practice that causes substantial delays in completion of projects, and has negative implications for the development process.
On the revenue side, net revenue receipts - sum of both tax and non-tax revenues after excluding the provincial share in revenues - indicate a big jump of 23.5 percent in 2011-12 compared to revised estimates of 2010-11. Given the slowdown in economic activities, security challenges and threats of natural disasters, it is an overestimation that seems unlikely to be met.
Despite the reservations expressed above and assuming the statistics as presented in the federal budget documents are correct, what would be the federal and overall budget deficit (aggregate of federal and provincial budget deficit/surplus)? The computation of the federal budget deficit simply requires subtraction of total expenditures (sum of net current expenditures and federal PSDP) from total revenues (sum of net revenue receipts and net lending to others). The result shows a budget deficit of Rs 8,51.8 billion and Rs 1,156.4 billion as per budget and revised estimates of 2010-11. For 2011-12, it is Rs 975.5 billion. Neither of them is 4 percent of GDP.
In order to lower the gap to 4 percent of the GDP, the federal budget documents show a provincial surplus of Rs 166.9 billion in 2010-11 and Rs 125 billion in 2011-12. As a result, overall budget deficit in 2011-12 declines to Rs 850.5 billion from Rs 975.5 billion, which is exactly 4 percent of the projected GDP. To check the consistency of provincial surplus, province-wise and aggregate budget surpluses/deficits are computed by using provincial budget documents. Surprisingly, the result indicates that only Khyber Pakhtunkhwa has projected a marginal budget surplus of Rs 2.5 billion for 2011-12.
Among the rest of three provinces, while Punjab has a balanced budget, Sindh and Baluchistan have projected budget deficits of Rs 3.1 billion and Rs 4.9 billion respectively. The sum of these provincial budgetary balances result in a net deficit of Rs 5.5 billion instead a surplus of Rs 125 billion for 2011-12. The situation in 2010-11 was even worse when the aggregated provincial budget deficit was over Rs 40 billion instead a surplus of Rs 166.9 billion.
Aggregation of provincial and federal budget deficits gives a relatively higher overall budget deficit of Rs 981 billion, which is 4.6 percent of the projected GDP for 2011-12. This overall budget deficit is likely to reach 5 percent of GDP, if the monetary impact of overestimation in revenues and underestimation in current expenditures of the federal government is added.
Based on these estimations, it can be inferred that the large deviation in budgeted and revised estimates of the budget deficit is based on systematic errors, which may have been made intentionally to show a lower deficit within the prescribed limits of IMF.
Continuation of such budgeting practices would further erode the credibility of the government among people, donor agencies and in the eyes of the IMF. Moreover, it creates uncertainties in federal and provincial fiscal planning, which have negative implications for development. The writer works as Principal Economist at the Social Policy Development Centre. He can be reached at muhammadsabir@spdc.org.pk

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COMPUTATION OF OVERALL BUDGET DEFICIT

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                                                   2010-11                 2011-12   Growth (%)

Rs (bn)                                                 BE          RE          BE   RE over BE   BE over RE

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Net Revenue Receipts                                 1,377       1,238       1,529        -10.1         23.5

Plus      Net Lending to Provinces and others         19.3        37.4        19.3         93.8        -48.4

Minus   Current Expenditures                         1,998       2,296       2,315         14.9          0.8

Plus      Repayment of Foreign Loans                 174.4       127.4       243.2        -26.9         90.9

Minus   Federal PSDP                                 424.9       263.4         452          -38         71.6

Federal Budget Surplus(+)/Deficit (-) A             -851.7   -1,156.30      -975.6         35.8        -15.6

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Provincial Budget Surplus/Deficit

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Punjab                                                -2.5           0           0            -            -

Sindh                                                -31.1       -32.2        -3.1            -            -

Khyber Pakhtunkhwa                                       0          -5         2.5            -            -

Balochistan                                           -6.5          10        -4.9            -            -

Provincial Budget Surplus(+)/Deficit (-) B           -40.1       -27.2        -5.5

OVERALL Budget Surplus(+)/Deficit (-) (A+B)         -891.8   -1,183.50      -981.1         32.7        -17.1

GDP (MP)                                            16,745      18,063      21,173          7.9         17.2

BUDGET DEFICIT (as %age of GDP)                        5.1         6.4         4.6

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