The state of provincial finances

The financial year, 2023-24, has started with an ambitious target for generation of cash surpluses by the four provincial governments by the end of the year. This is essential if there is to be a primary surplus in the overall budgetary position of the federal and provincial governments combined, as committed with the IMF under the Stand-by Facility.

According to the document, Budget-in-Brief for 2023-24, published by the Federal Ministry of Finance, the four provincial governments are expected to generate a sizeable cash surplus of Rs 600 billion, equivalent to almost 0.6% of the projected GDP in 2023-24.

The cash surplus actually generated in 2022-23 was much smaller at Rs 154 billion. Therefore, there is the expectation that somehow the provincial governments will generate a cash surplus almost four times larger than the level actually achieved last year.

The fundamental question is how will this extremely ambitious target be achieved? The Staff Report of the IMF, relating to the new Stand-by Facility, gives the projections of the key budgetary magnitudes of the four Provincial governments combined in 2023-24. These are shown in Table 1.

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Table 1
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Budgetary Projections of the Provincial
Governments combined in 2023-24
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                                                    (Rs in Billion)
                             2022-23      2023-24             g (%)
REVENUES                     5298         6546                 23.6
Transfers                    4223         5470                 29.5
Own-Tax Revenue              650          868                  33.5
Own-Non-Tax Revenue          425*         208
EXPENDITURE                  5144         6035                 17.3
Current                      3859         4595                 19.1
Development                  1285**       1440                 12.1
PROVINCIAL CASH SURPLUS      154          511
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*Including Federal Loans |** Including Stat Discrepancy
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Source: IMF Staff Report, July 2023
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According to Table 1, the IMF has a somewhat more moderate expectation about the combined provincial cash surplus in 2023-24 at close to Rs 500 billion, as compared to the projection of Rs 600 billion by the Ministry of Finance.

The IMF has projected a big increase in provincial tax revenues of over 33% in 2023-24. This is in sharp contrast to a growth rate of only 6% achieved in 2022-23. Examination of the Budget Speeches by the respective provincial Finance Ministers reveals that no provincial government has proposed major taxation proposals for 2023-24. Therefore, the projected growth rate of 33% in provincial tax revenues is extremely unlikely.

The other doubtful projection by the IMF relates to the growth rate of current expenditure in 2023-24 of 19%. All four provincial governments have announced 30% or more increases in pay of all employees and hefty increases in pensions. In the absence of such increases, there was still an escalation in current expenditure of the four provincial governments combined of 21% in 2022-23.

Now with the big increase in employment costs, the projected growth rate of 19% is very much on the low side. It is more likely to be even higher than 30%.

Overall, the probability of a sizeable cash surplus of Rs 500 billion to Rs 600 billion in 2023-24 by the provincial governments is very low.

In fact, the State Bank of Pakistan has given the financial position of each provincial government as of 15th September, 2023. The flows from July 1 to September 15, 2023 are quantified.

The SBP numbers portray a very worrying picture. Rather than the generation of cash surplus, the four provincial governments combined are in a deficit of Rs 161 billion. During the same period of last year, there was a combined cash surplus of Rs 65 billion. The emergence of a cash deficit is not surprising given the likely developments in 2023-24 identified above.

Three of the provincial governments are in a deficit position as of September 15. The only province with a surplus is Balochistan government. The largest deficit is that of the Punjab government of over RS 110 billion. The position on the same date last year was that the only government in deficit was of Sindh.

The absence of a large cash surplus in 2023-24 of the four provincial governments combined will render it extremely difficult to generate a primary surplus of 0.4% of the GDP in the consolidated budgetary position by the end of the year as agreed with the IMF.

The consequence is that in the forthcoming quarterly reviews of the SBF by the IMF major actions may be asked for in the realm especially of expenditure cuts.

The caretaker government ought to consider involving the 10th NFC in preparing a resource mobilization plan for the provincial governments.

This will focus on development of the grossly underexploited provincial progressive taxes like the agricultural income tax, urban immoveable property tax and the sales tax on services.

The 7th NFC had set a target for the provincial tax-to-GDP ratio at 1.2% of the GDP, especially after the fiscal powers to levy a sales tax on services were given to the provincial governments. However, the ratio in 2022-23 was under 0.8% of the GDP.

Despite the presence of strong fiscal powers and large tax bases, the provincial governments currently contribute only 9% to national tax revenues, as compared to over 30% by the states in India. Top priority may then be attached by the newly elected government to implementing the provincial resource mobilization plan.

Copyright Business Recorder, 2023