Budgetary outcome in 1QFY21

The Ministry of Finance (MoF) has released the results of the fiscal operations for the first quarter of 2020-21. The consolidated fiscal deficit of the Federal and Provincial Governments is 1.1 percent of the GDP. This is somewhat higher than the deficit of 0.7 percent of the GDP in the first quarter of 2019-20.

There is one change in the budgetary classification of revenues. Previously, the petroleum levy and some other small revenue sources were included in the category of other taxes besides the FBR taxes. Now they have been classified as non-taxes.

The first worrying outcome is the absence of any increase in total Federal revenues. Revenues have aggregated to Rs 1354 billion as compared to Rs 1359 billion in the first quarter of 2019-20. According to the Federal Budget of 2020-21 revenues are projected to increase by 14 percent. Therefore, there is already a shortfall in revenues of Rs 190 billion.

FBR revenues have shown a growth rate close to 5 percent. The target growth rate for the year as a whole is as high as 24 percent. In particular, income tax revenues have risen by only 2 percent while customs duty revenues have remained unchanged. Both sales tax and excise duty have shown higher growth rates of 8 percent and 10 percent, respectively.

Clearly, the slowdown of the economy after COVID-19 explains the lack of buoyancy in tax revenues. It remains a mystery as to why the MoF set a target for growth in FBR revenues of as high as 24 percent in 2020-21 given the state of the economy. The resulting shortfall already is Rs 180 billion. If the growth rate in revenues remains low at 5 percent throughout the year the annual shortfall in 2020-21 will be as large as Rs 750 billion in FBR revenues.

Turning to non-tax revenues, they have actually fallen by as much as 13 percent. This has happened despite the more than doubling of revenues from the petroleum levy. SBP profits have plummeted by over 43 percent and other non-tax sources have also yielded 30 percent less revenues. The big fall in SBP profits is attributable to the lower interest rates on the stock of government bonds held by the central bank.

There are also clear indications that the MoF has held back some transfers due to the Provincial Governments under the provisions of the 7th NFC Award. The shortfall is of almost Rs 100 billion. This has artificially reduced the budget deficit of the Federal Government and brought down the cash surplus of the Provinces without changing the consolidated deficit.

Expenditure of the Federal Government has shown a growth rate of almost 16 percent in the first quarter. The growth in expenditure is expected to be restricted to only 5 percent in the Federal Budget of 2020-21. Therefore, there has already been excess expenditure of Rs 120 billion in the first quarter.

Debt servicing has shown a surprisingly high growth rate of 30 percent. The expectation was that with the big fall in the policy rate from 13.25 percent to 7 percent, the cost of domestic borrowing would be less. But the problem is the excessive borrowing in the previous two years in the form of long-term PIBs. This has resulted in a strong 'lock in' effect and effectively implied a continuation of high interest rates.

Defence services expenditure has effectively shown a fall of 8 percent. This is line with the commitment by the military establishment that maximum economy will be exercised in defence spending. This was demonstrated also in 2019-20 and has helped in containing the budget deficit.

The big surprise is the virtually no expenditure on subsidies. The major expenditure under this head is on the tariff differential subsidy to the power sector. The absence of a quarterly payment implies a build-up of circular debt in the sector.

Grants, however, have increased by as much as 37 percent in the first quarter. They are budgeted to rise by 12 percent in 2020-21. It appears that payments against contingent liabilities have been higher than anticipated. These relate to the debt of State Owned Enterprises (SOEs) guaranteed by the Federal Government. It appears that the financial position of SOEs has deteriorated and they have been unable to meet a larger part of their debt servicing obligations. The outstanding debt of SOEs currently stands at the high level of Rs 1490 billion.

Development spending and lending has also been higher by 35 percent in relation to the level in the corresponding period of 2019-20. However, PSDP-related spending has actually fallen by Rs 10 billion to only Rs 83 billion. The target for development expenditure on projects in 2020-21 is Rs 650 billion. Therefore, only 13 percent of the envisaged spending has been undertaken in the first quarter. The hope that larger development expenditure would provide a fiscal stimulus to the economy has not been realized yet. The increase is in lending.

Overall, the Federal budget deficit in the first quarter is reported at Rs 528 billion, 11 percent higher than the magnitude in the corresponding quarter of 2019-20. The expectation in the 2020-21 budget is that the deficit at the Federal level will be 5 percent lower in absolute magnitude in relation to the level in 2019-20. This has clearly not happened yet, due to poor performance of revenues and higher than projected spending.

Therefore, the real concern is the likely magnitude of the consolidated budget deficit in 2020-21. The target is 7 percent of the GDP. The IMF expects it to be even lower at 6.6 percent of the GDP. But the way the budgetary process is proceeding there is a high level of risk that the budget deficit could approach the large deficit of 8.1 percent of the GDP in 2019-20.

This raises the fundamental question of the relationship with the IMF. In the absence of an operational programme, access to external borrowing may become more limited and put pressure on the foreign exchange reserves. Already, in the first quarter the net inflow of external assistance was $1 billion, when the target for the year is $5 billion. This is despite greater support by the World Bank and Asian Development Bank to counter the negative effects of COVID-19 and the debt relief provided by the G-20.

A return to an operational programme with the IMF and completion of the second review will require enhancement in power tariffs to counter the increase in the circular debt of the sector and a big mini-budget. This is extremely difficult given the prevailing economic and political situation.

Clearly, Pakistan today stands between the devil and the deep blue sea.

(The writer is Professor Emeritus at BNU and former Federal Minister).

Copyright Business Recorder, 2020