A constrained budget

The federal budget of 2022-23 has been presented in a difficult and uncertain economic and political environment in the country. Foreign exchange reserves are at a very low level of just under $9 billion and fiscal policy must be contractionary to suppress aggregate demand and thereby limit the level of imports. This is reflected in the concerns of the IMF which has insisted that the federal budget be framed in such a way that a primary surplus is generated in 2022-23.

As opposed to this, the coalition government will want to ensure that a budget with high additional taxation and restraints on expenditure, especially in the form of relief at a time of high inflation, does not jeopardize its prospects in the next elections. The fundamental question is how the federal budget reconciles these competing objectives?

The first area of focus is on the targeted reduction in the size of the budget deficit to determine the extent to which it is contractionary in nature. The year 2021-22 is likely to close with a large budget deficit approaching 6.6 percent of the GDP, when the target was lower at 5.4 percent of the GDP. There is likely to be a large primary deficit of almost 1.7 percent of the GDP, as compared to the target of a small primary surplus.

The budget deficit presented to the National Assembly is targeted at 4.9 percent of the GDP for 2022-23. This implies a big reduction of 1.7 percent of the GDP in relation to the likely level in 2021-22.

Success in this big fiscal deficit reduction will lead to a primary surplus of 0.2 percent of the GDP, as asked for by the IMF. This extent of improvement in key public finance magnitudes has seldom been seen before and somewhat stretches the limits of credibility.

The key budgetary magnitudes for 2022-23 are presented in Table 1 and a comparison made with the likely outcome in 2021-22.

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                           Table 1
               Key Budgetary Magnitudes - 2022-23
                                                  (% of GDP)
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                           2021-22              2022-23
                       (Revised Estimate)   (Budget Estimate)
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Revenues                      11.0                       11.5
Tax Revenues                   9.0                        9.0
Non-Tax Revenues               2.0                        2.5
Transfer to Provinces         -5.2                       -5.2
Net Revenue Receipts           5.8                        6.3
Total Expenditure             13.3                       12.2
Current Expenditure           12.5                       11.1
Development Expenditure        0.8                        1.1
Federal Budget Deficit        -7.5                       -5.9
Provincial Cash Surplus        0.9                        1.0
Consolidated Budget Deficit   -6.6                       -4.9
Primary Surplus/Deficit       -1.7                       +0.2
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Source: Federal Budget Documents
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The strategy for deficit reduction is very clear from Table 1. While there appears to be no significant additional fiscal effort in FBR revenues which are projected to remain at 9 percent of the GDP, the level of non-tax revenues is expected to rise significantly by 0.5 percent of the GDP.

Evidence of proposed economy in current expenditure is clearly visible. It is to be brought down from 12.5 percent of the GDP to 11.1 percent of the GDP. This type of reduction has seldom been achieved before. A modest increase of 0.3 percent of the GDP is proposed in development expenditure in relation to the depressed level in 2021-22 of only 0.8 percent of the GDP.

The bottom line is federal budget deficit reduction of 1.7 percent of the GDP, a one-third due to higher revenue-to-GDP ratio and a two-thirds because of containment of expenditure. There is need to assess the feasibility of these targets. This is attempted below.

The lack of change in the tax-to-GDP ratio even in the presence of a number of taxation proposals is appropriate. The underlying elasticity of the tax system is likely to be hampered by efforts at restricting imports to bring down the current account deficit, which will adversely affect import- based tax revenues.

However, the 49 percent increase in non-tax revenues is bordering on the very ambitious. It is based primarily on a phenomenal increase in revenues from the petroleum levy from Rs 135 billion in 2021-22 to Rs 750 billion. This implies that from the start of the next financial year this levy will have to be brought back at a very high rate of at least 30 Rs per liter. Such a large petrol levy is likely to raise the price of motor spirit and HSD oil close to Rs 300 per liter. This could be politically infeasible as it will contribute to a quantum jump in the rate of inflation and possibly lead to widespread public protests.

The pressure on raising tax revenues and the levy on petroleum products is partly attributable to the likely slump in SBP profits by Rs 174 billion in 2022-23. This is after the shortfall of Rs 178 billion in 2021-22. The question is why has such a low level of SBP profits of Rs 300 billion been targeted for in 2021-22? Is this the consequence of the change in relationship of the central bank with its owner, the federal government, following the granting of virtually total autonomy to it?

Turning to the big economy in current expenditure, the proposed growth rate in 2022-23 is of only 2 percent. This also looks infeasible, especially when there will be pressure on operating costs due to the on-going high and rising rate of inflation.

The big proposal is to reduce subsidies by Rs 815 billion, equivalent to a massive cut of 54 percent. This is predicated largely on a big phasing out of subsidy by Rs 500 billion to WAPDA/PEPCO. Presumably, the big jump in electricity tariff by almost Rs 8 per kwh will contribute to a sizeable reduction in the circular debt. However, if power loadshedding persists due to shortage of fuel, then IPP revenues will be significantly reduced. Therefore, the Rs 500 billion reduction in subsidy may not be fully forthcoming.

There is a proposed jump of 45 percent in the size of the PSDP. However, if the big growth in non-tax revenues or/and the large cut in subsidies is not achieved, then as happened this year there will be a sizeable truncation in PSDP allocations in 2022-23.

Finally, there is the expectation of a large provincial cash surplus of Rs 800 billion in 2022-23. As of the end of May 2022, this surplus is Rs 371 billion and the assumed surplus of Rs 570 billion by the end of 2021-22 is unlikely. This raises doubts also about the very big jump next year.

Overall, the budget of 2022-23 has been formulated in a politically constrained environment while under pressure from the IMF to show a primary surplus next year. A number of problematic targets have been identified above. Given the continuing negative developments in the global economy, especially the big jump in oil and other commodity prices, we hope that the IMF will show some understanding and support Pakistan at a time when the country is in a very fragile economic situation.

Copyright Business Recorder, 2022