Burgeoning fiscal deficit

The information on fiscal operations during the first three quarters of 2021-22 has been released recently by the Ministry of Finance. The financial position of the Federal government appears to be under great stress, with a budget deficit of Rs 3165 billion, equivalent to 5.9 percent of the GDP of 2021-22. The GDP is taken as the level projected at the time of presentation of the budget.

The budgeted size of the federal deficit is Rs 3,990 billion. Therefore, there is space for incurring a deficit of only Rs 825 billion in the last quarter. Historically, the quarterly deficit is by far the largest in the last quarter. It is almost equal to the combined deficit in the first three quarters. Therefore, are we seeing a federal budget deficit in 2021-22 which will approach the record level of Rs 6,000 billion or more?

Why has the deficit ballooned so much in the first three quarters? The answer lies both on the revenue and on the expenditure fronts. FBR tax revenues have performed well due to the big jump in the import tax base and have achieved a high growth rate of over 28 percent. However, if the annual target of Rs 6,100 billion is to be achieved then the growth rate required in the last quarter is almost 30 percent. This will be difficult to achieve because the growth rate of imports has come down.

There has been a significant shortfall in non-tax revenues in the first three quarters. They have declined by over 14 percent. The primary reason is the substantially lower yield from the petroleum levy of 66 percent. The target for the year is Rs 610 billion and the collection from the levy in the first nine months of Rs 125 billion, with the prospect of zero collection in coming months.

Overall, federal revenues were projected to grow by 20 percent in the 2021-22 budget. The growth rate in the first three quarters is under 18 percent, with the prospect of significantly lower growth rate in the last quarter. There could be a shortfall in revenues of over Rs 600 billion by the end of the year.

Turning to the growth rate of federal expenditure, it is estimated in the budget at a relatively high 19 percent, especially with a big 45 percent increase in PSDP spending. The objective was to stimulate the growth process.

However, the outcome in the first three quarters is even higher with a growth rate in expenditure of as high as 27 percent, revealing no attempt at economy in expenditure. The growth in current expenditure is 21 percent while there is a 45 percent increase in development spending. Within current expenditure, there has been an extraordinary jump in the outlay on subsidies of 182 percent, presumably due to larger payments to IPPs. Grants have also risen sharply by 102 percent. Combined the increase in these two heads is as much as Rs 871 billion, whereas the annual provision for increase is Rs 514 billion.

The consequence of lower revenues and higher expenditure than provided for in the budget is that the federal deficit is up by 37 percent over the actual level in the corresponding period of last year. Such a large deviation reflects poorly on the quality of financial management.

Fortunately, with a 30 percent growth in transfers from the federal government, the four provincial governments combined have shown a large cash surplus of Rs 600 billion, 45 percent more than the level achieved by the end of March last year. This has contained somewhat the consolidated deficit at Rs 2,566 billion, equivalent to 4.8 percent of the originally projected GDP in 2021-22.

The corresponding deficit was 3.6 percent of the GDP in the first three quarters of 2020-21. The last quarter had seen an additional deficit of 3.5 percent of the GDP. Similarly, it can be expected that the annual fiscal deficit will be nearly double that of the first three quarters and approach the highest ever level of 9.6 percent of the GDP in 2021-22, equivalent in absolute terms to almost Rs 5,200 billion.

The deviation from the budget target will be Rs 1,680 billion, equivalent to a rise of as much as 49 percent. The last time such a large deviation was experienced was in 2018-19, when the budget deficit rose to the record level of 8.9 percent of the GDP.

The implied primary deficit is as large as Rs 1,400 billion, the highest ever. The overall increased requirement of domestic borrowing has already led to record high yields on government bonds and will put pressure on the cost of debt servicing in the forthcoming financial year of 2022-23 and beyond.

There is need to derive the implications of the burgeoning budget deficit on the relationship with the IMF and the outcome of quarterly reviews of the Program. The primary deficit, according to the performance criteria, was expected to be Rs 389 billion at the end of the third quarter. Instead, it is somewhat larger at Rs 448 billion. The expectation in the program is that the year will close with a primary surplus of Rs 25 billion. Instead, it will be vastly larger. The eighth review will be especially difficult for the government in the presence of such a large deviation.

There is now the expectation that the IMF will expect much larger adjustment on the fiscal front in the budget of 2022-23 and achieve the now impossible target of 4.5 percent of the GDP. Also, if a primary deficit is to be avoided in the coming year, then taxation proposals of almost 1.5 percent of the GDP will be required in the 2022-23 budget.

We wish the new government success in presenting a budget for 2022-23 which will contain a well thought out set of taxation proposals and mechanisms for achieving greater economy in expenditure so as to contain the fiscal deficit.

Copyright Business Recorder, 2022