Key features of budget 2020-21

ARTICLE: The objective of this article is to highlight the key features of the Federal and Provincial Budgets for 2020-21, starting with revenues, moving on to issues of expenditure and concluding with the size and financing of the budget deficit.

The economy is expected to recover in 2020-21. The GDP growth rate is projected to rise strongly from negative 0.4 percent in 2019-20 to 2.1 percent in 2020-21. This is in contrast to more dire projections of growth in 2020-21 of minus 0.2 percent by the World Bank and minus 1 percent by the UN. The outcome will depend on when the peak of Covid-19 occurs and the pace of recovery thereafter.

Revenues

The three year budgetary framework developed by the Ministry of Finance is ambitious. It envisages a rise in the tax-to-GDP ratio from 11 percent in 2019-20 to 14.5 percent by 2022-23. Simultaneously, current expenditure of the Federal and Provincial Governments combined will be brought down from 20.9 percent to 18.8 percent of the GDP while the level of development spending will be raised from 2.6 percent to 3.3 percent of the GDP. Consequently, the budget deficit is targeted to fall from 9.1 percent of the GDP in 2019-20 to 4.8 percent of the GDP in 2022-23.

However, contrary to the earlier budgetary frameworks, the tax-to-GDP ratio at the Federal level has fallen sharply from 11.2 percent of the GDP in 2017-18 to 9.3 percent in 2019-20. Earlier it had risen significantly from 8.4 percent of the GDP in 2012-13.

The federal government claims to have presented a 'tax-free' budget, yet tax revenues are expected to rise by 27 percent in 2020-21. The fastest growth is expected in sales tax of over 34 percent, followed by 26 percent increase in income tax revenues. The two major tax bases are large-scale manufacturing and imports. According to the Annual Plan for 2020-21, both these tax bases are expected to contract in real terms next year. Therefore, the FBR revenue target is extremely ambitious. There could be a shortfall of over Rs 750 billion. As such, there is the expectation that once the peak of COVID-19 is over, the Federal Government will have to announce a big 'mini' budget.

Non-tax revenues reached a record level of Rs 1.3 trillion, as compared to the budget estimate of Rs 0.9 trillion. This was primarily due to the highest ever profit of Rs 785 billion by the central bank, which contributed to restricting the size of the primary deficit to 2.5 percent of the GDP despite a record budget deficit of 9.1 percent of the GDP in 2019-20. However, non-tax revenues are expected to fall by 15 percent in 2020-21, due to the return of SBP profits to a more normal level following the sharp drop-in interest rates.

Expenditure

Given the tendency for runaway budget deficits, it was reassuring to hear in the Federal Budget Speech that 100 organizations were either being shut down, privatized, transferred to the Provinces or merged. There is a need to inform the Parliament the names of these organizations and the likely annual budgetary savings. The budget documents also indicate that the number of Divisions is down from 42 to 39 next year. The three Divisions which have ceased to exist are Statistics, Textiles and Capital Development and Administration.

The cost of salaries and allowances of Federal Government employees has been doubling every five years while pensions are rising even faster and doubling once every four years. Inclusion of operating costs raises the total budgetary allocation for these three heads to Rs 2204 billion in 2019-20. This implies a growth rate in 2020-21 of 3 percent, even though no salary increases have been granted in the budget. These three heads combined constitute almost 29 percent of Federal expenditure. Ten years ago, the share was 24 percent.

Rising current expenditure and falling revenues as a percentage of the GDP have left increasingly less 'fiscal space' for development spending. Consequently, the combined level of development expenditure by the Federal and the Provincial Governments combined which was 5.0 percent of the GDP in 2012-13 is now half the level, at 2.5 percent of the GDP. This is one of the major reasons for the secular decline in the GDP growth rate.

Despite a high level of relief spending required to mitigate the negative impact of Covid-19, there is likely to be a fall of 40 percent in subsidies and of 23 percent in grants in 2020-21. Clearly, the redistributive role of fiscal policy will diminish. In fact, the Budget Speech of 2020-21 claims that the budget is a 'relief' budget. This is contradicted by the 15 percent decline in cash transfers to the poor and other pro-poor initiatives in the Benazir Income Support Program and for Social Protection' in comparison with actual expenditure in 2019-20.

The cost of debt servicing has increased exponentially in the last two years, from Rs 1500 billion to Rs 2709 billion in 2019-20, a big jump of 81 percent. Both bigger primary deficits and higher interest rates have contributed to this jump. Debt servicing is now the largest component of Federal expenditure with a share of 46 percent.

However, the rate of increase is expected to moderate to 9 percent in 2020-21. There was, in fact, the expectation that it would fall next year given the big decrease in the policy rate of the SBP from 13.25 percent to 8 percent in the last few months. Unfortunately, this has not happened because of a seriously flawed policy of debt management whereby long-term bonds continued to be floated when interest rates were at a peak rather than opt for short-term borrowing. This has created a strong 'lock-in' effect. In 2019-20, over 70 percent of the domestic borrowing was in the form of PIBs. As such, there will be a delayed reduction in debt servicing costs.

There was also a big shortfall in development spending of over 32 percent in 2019-20 in relation to the budgetary targets. The contraction was greater in the case of provincial governments because of the big shortfall in Federal transfers. The total development spending proposed for 2020-21 remains 17 percent short of the budgeted level in 2019-20. It is lower by 26 percent in the case of the Provinces and by 7 percent at the Federal level.

The priorities in the Federal PSDP of Rs 650 billion of 2020-21 are highways with share of over 18 percent. Power distribution projects have a share of only 6 percent and water resources, 12 percent. The time has come to shift the focus of CPEC towards development of the SEZs and construction of dams in which Chinese contractors have enormous expertise.

The unfortunate reality is that if the budgetary strategy had not been severely constrained by the IMF then one of the prime levers for revival would have been expenditure on more labor-intensive projects with short-gestation periods. This includes lining of irrigation canals, construction of rural roads, tree plantation, etc. The annual development outlay should have been fixed at above Rs 1.6 trillion as compared to budgetary target in 2020-21 of just over Rs 1.3 trillion.

Budget deficit

The primary reason for the transformation of the Provincial Governments from being cash surplus to having cash deficits is the big shortfall in transfers. According to the 2019-20 Budget the level of Federal transfers was expected to be Rs 3411 billion. The year will end with actual transfers of Rs 2512 billion, implying a huge shortfall of almost Rs 900 billion. Consequently, the revised estimates for 2019-20 indicate that the combined deficit of the provinces will be Rs 81 billion. The IMF estimate is much higher at Rs 205 billion.

The greater uncertainty in federal transfers has motivated the Finance Advisor to suggest that the provincial governments may take their own estimates of the likely magnitude of Federal transfers in 2020-21 and frame their budgets accordingly. This is contrary to good financial practices in a Federation.

Further, the four Provincial Governments are now expected to generate a cash surplus of Rs 242 billion in 2020-21. This will only happen if the budget growth of 27 percent in Federal transfers is achieved. However, the Sindh Budget for 2020-21 is in deficit even with the 27 percent growth in transfers. Fortunately, the Punjab Government with the same expected growth in transfers has been able to show a cash surplus of Rs 125 billion in its budget for 2020-21. Khyber-Pakhtunkhwa has produced a balanced budget while Balochistan has also announced a deficit budget.

The MoF has claimed that a primary surplus was generated in the first three quarters of 2019-20. This is the difference between revenues and expenditure, excluding the cost of debt servicing. The magnitude was 0.6 percent of the GDP. The Budget Speech has made the claim that this is the first time a primary surplus has been generated. This is not factually correct. A similar primary surplus was generated in the first three quarters of 2015-16.

The reported consolidated budget deficit for 2019-20 at 9.1 percent of the GDP could be even higher and approach 10 percent of the GDP. Revenues have probably been overstated by 0.2 percent of the GDP and provincial deficit understated by 0.6 percent of the GDP. If the release of data subsequently on fiscal operations confirms the higher deficit, then this will be the first time that the deficit has approached a double-digit level. The fact that revised estimates for 2019-20 have not been made available in the primary budget document, Budget in Brief, does create the perception that the deficit this year has been significantly understated.

A similar problem is likely to arise with the estimation of the consolidated budget deficit at 7 percent of the GDP in 2020-21. FBR tax revenues have been overstated by almost 1.5 percent of the GDP while the level of development spending is likely to be higher by almost 0.6 percent of the GDP given the larger size of ADPs announced by the provincial governments in relation to the level envisaged. Also, if other governments come under pressure to grant a similar wage increase as Sindh, the current expenditure could be 0.5 percent of the GDP higher than projected. Consequently, the consolidated budget deficit could once again approach 9 percent of the GDP in 2020-21. It will be interesting to see how the IMF reacts to this slippage, especially in the Provincial budgets.

There is also the claim that there has been no direct borrowing from the SBP as per one of the performance criteria in the IMF Program. However, indirectly through reverse repo injections the SBP has provided liquidity to commercial banks for buying Government paper. By June 05, banks had invested as much as Rs 2112 billion in MTBs and PIBs. This is over twice the increase in deposits.

Public debt will approach Rs 38 trillion by the end of 2019-20. This will be equivalent to 90 percent of the GDP, way above the limit set by the Fiscal Responsibility and Debt Limitation Act. In absolute terms, it will increase by Rs 12 trillion during the first two years of the PTI government. Earlier, the increase was almost Rs 11 trillion during the five-year tenure of the PML(N) government. The former increase has been accelerated by almost Rs4.5 trillion due to the big escalation in interest rates and rapid depreciation of the rupee.

The Budget of 2019-20 had set a very ambitious target of almost $20 billion for gross inflow of external assistance from diverse sources. This would have implied a net inflow of $12 billion after external debt repayment. However, estimates are that the net inflow will be $5.8 billion, less than half the targeted amount. This vividly highlights the growing difficulties in accessing external financing after the Covid-19 and more negative perceptions of Pakistan's economy. Even after the receipt of $1.4 billion from the IMF Rapid Financing Facility foreign exchange reserves have fallen close to $10 billion. This is barely adequate to provide import cover of two months.

Apparently, there was an understanding with the IMF that no salary or pension increases will be announced in the budgets. Clearly, there has been a big failure in coordination with the Provincial Governments and the Sindh budget has included increases in remuneration of 5 to 10 percent. This could also have spillover effects. There is somewhat greater uncertainty now about the future of the IMF Program unless a plan of resource mobilization of at least Rs 700 billion has already been presented to the IMF and is awaiting implementation during the year.

Overall, the Federal Budget of 2020-21 is relatively passive and lackluster. Given the prevailing conditions, the expectation was that the Budget will be designed to focus on revival of the economy and on mobilizing the required resources through a redistributive fiscal policy, broad-basing and strong measures against tax evasion. This has not happened. Consequently, there has been increase in uncertainty about the state of the economy during and after Covid-19 and about the future of the IMF Programme.

(The author is Professor Emeritus and former Federal Minister)