Budget strategy paper for FY2021-22

The Federal Budget for 2021-22 is likely to be presented on the 11th of June 2021. The Ministry of Finance must be putting together the key targets for the next financial year. Two important considerations will dominate the design and strategy for next year’s budget. First, the budgetary outcome in 2020-21, especially the level of FBR revenues and quantum of debt servicing, will define the base from which projections can be made for 2021-22. The bottom line will be the extent to which to budget deficit for 2020-21 will be adhered to.

The second key consideration is the budget strategy for 2020-21 already agreed to with the International Monetary Fund (IMF) and included in the recently released Medium-term Budget Strategy paper. It has also received the cabinet approval and been presented to the Finance Committee of the National Assembly. The fundamental question is the extent to which there is scope for deviation from the targets embodied in the MTBS in light of rapid deterioration in the state of economy following the intensification of the third wave of COVID-19. Will Pakistan be able to get the IMF to agree to scaling down of the targets? First indications are that the IMF will wait till the end of the sixth review for any formal discussions with the Authorities.

The nine-month fiscal operation numbers for 2020-21 have been released a few days ago. They reveal a mixed picture. FBR revenues have shown a growth rate of 12 percent, while the target growth rate for the year is 24 percent. Therefore, the growth rate in FBR revenues that is required in the last quarter is over 64 percent. This is very unlikely especially with widespread lockdowns in the country. Already, on a month-to-month basis there has been a decline of almost 8 percent in the Quantum Index of Manufacturing. Consequently, the shortfall in FBR revenues will be almost 1 percent of the GDP. Fortunately, other tax revenues and non-tax revenues are on target as of March 2021.

The Federal Budget of 2020-21 had projected a modest growth in debt servicing of below 9 percent. The actual growth has been 12 percent. If this trend continues then the actual level of debt servicing will be Rs 80 billion over the projected amount, equivalent to 0.2 percent of the GDP.

The good news is that the Federal Government has succeeded in economizing on other current expenditure and limited the growth in the first nine months to only 3 percent. However, the Budget had envisaged that there would be no growth in current expenditure, excluding debt servicing. Therefore, here again if the nine-month trend persists than the spillover will be approximately of Rs 100 billion, under 0.3 percent of the GDP.

The big shortfall is in development spending. The policy appears to reduce development expenditure to minimize the deviation from the deficit target. As such, federal PSDP, other development expenditure and net lending combined have been 15 percent lower than the level attained in the corresponding period of last year. If the cutback continues then development spending will be 0.2 percent of the GDP lower than budgeted in 2020-21.

Overall, we have the following likely outcomes in 2021-22:

=================================
                   Deviation from
                 Budget Estimates
                       (% of GDP)
=================================
FEDERAL
REVENUES                     -1.0
Tax Revenues                 -1.0
Non-Tax Revenues              0.0
FEDERAL
EXPENDITURE                   0.3
CURRENT
EXPENDITURE                   0.5
Debt Servicing                0.2
Other                         0.3
DEVELOPMENT
EXPENDITURE                  -0.2
BUDGET
DEFICIT                      -1.3
=================================

Therefore, the budget preparation exercise for 2021-22 is hamstrung by a higher budget deficit of almost 8.4 percent of the GDP in 2020-21, due mostly to a shortfall in FBR revenues of over Rs 450 billion. The committed deficit target in the MTBS for 2021-22 is 6 percent of the GDP. Therefore, the fundamental question is whether a big deficit reduction of 2.4 percent of the GDP can be achieved in one year? The likelihood is reduced if the third COVID-19 attack continues and the economy is faced with a slow-down at least up to the initial months of 2021-22.

The FBR revenue target implicit in the MTBS is of Rs 5900 billion for 2021-22. Given the likely base figure of Rs 4500 billion, this will require an increase of Rs 1400 billion in one year, implying an annual growth rate of over 30 percent. This is beyond the realm of possibilities.

The more doable target in 2021-22 for FBR revenues is Rs 5400 billion. This will lead to an increase in the tax-to-GDP ratio of 0.8 percent of the GDP with a growth of 20 percent in the level of revenues. There will, however, be a serious problem with achieving the target of over Rs 600 billion from the Petroleum Levy in 2021-22. At prevailing rates, the revenue will not exceed Rs 250 billion.

The targeted growth of 20 percent in FBR revenues will require taxation proposals of Rs 300 billion. This should be generated entirely from direct taxes and no enhancement proposed in tax rates or withdrawal of exemptions in indirect taxes to avoid any upsurge in the rate of inflation.

The taxation proposals in the income tax could include the following:

(i) Conversion of fixed and final taxation of dividends, interest income and capital gains into advance tax. Income tax returns will have to report both earned and unearned income and be subject to taxation on total income.

(ii) Changing the personal income tax from 12 to 6 slabs. The exemption limit to be raised to 750,000 Rs. The maximum rate to be reduced from 35 percent to 30 percent. The maximum tax rate of 30 percent to become applicable on annual income above Rs 15 million.

(iii) Introducing a progressive corporate tax, whereby companies earning a pre-tax return on equity above 20 percent will be required to pay an additional tax of 10 percent on the higher profits.

A challenging budget deficit target for 2021-22 is 7 percent of the GDP. The above proposals will make the tax system significantly more progressive. This target deficit will continue to imply limited growth in current expenditure, while allowing some space for a higher level of relief and health spending related to Covid-19. It should also be possible to raise the allocation for the PSDP by up to 15 percent.

The above modified targets are proposed given the continuing impact of Covid-19. If, of course, the third attack becomes milder and there is no recurrence of the pandemic then come December 2021 a mini-budget may be presented with some more taxation proposals.

The economy of Pakistan like that of other countries is passing through a difficult period largely due to successive COVID-19 attacks which have badly impacted on lives and livelihoods. We hope that the Federal Government will be successful in piloting through a Budget for 2021-22 which involves fiscal effort within realistic levels at this time with support from the IMF.

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

Copyright Business Recorder, 2021