Macro-fiscal forecasts for budget: IMF asks govt to strengthen capacity of FD

ISLAMABAD: The International Monetary Fund (IMF) has recommended Pakistan to strengthen capacity at the Finance Division to lead and coordinate macro-fiscal forecasts to support budget preparation, as well as increasing forecast cycles and synchronizing them with the budget.

The Fund in its “technical assistance report-improving budget practices” noted that the current organisation of the Finance Division is relatively fragmented and presents an obstacle to achieving a more strategic approach to budgeting.

The Fund also recommended introducing a strategic phase to the budget process, in line with the Public Financial Management Act (PFMA) 2019 and the accompanying Budget Manual; include more guidance and binding ceilings in the Budget Call Circular; and undertaking actions to minimise dual (“recurrent/capital”) budgeting.

The Fund asked Pakistan to consider reorganising the Finance Division with a focus on its budget and budget management functions, to bring the structure into line with good international practice.

The IMF has further recommended for preparing a PFM Digitalization Master Plan, establish a high-level Steering Committee to oversee coordination and implementation of the Plan, strengthen Fiscal Data Governance (FDG) practices, consider next steps after SAP life support ends in 2025, and review the budget preparation and budget execution business processes in FABS.

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Pakistan’s current budgetary process is largely bottom up and designed to gather information from divisions/ministries. Thus, no up-to-date fiscal projections or budget ceilings (in aggregate of broken down by sector) are included in the BCC that launches the budget process in January.

A top-down approach to budgeting is sometime called a “strategic phase” because it requires the finance ministry to define policy objectives for the budget, and its priorities for spending and revenue mobilisation.

There could be two options for adding a strategic phase to the budget process in Pakistan. First, the Budget Strategy Paper, currently released in April, could be brought forward to January, and issued with the Budget Call Circular. This approach makes it difficult to assemble the necessary data to update the economic and fiscal projections in time.

Second, the existing timetable for preparing and publishing the Budget Strategy Paper could be retained but a preliminary analysis of macro-economic developments and updated macro-fiscal projections and a calculation of available fiscal space and the IBCs could be included in the Circular.

The second option would represent a substantial improvement from existing practice because it would include the latest assessment (from the Economic Adviser’s Wing) of the state of the economy5 as well as the most recent data on fiscal trends and indicators which can be highly volatile even over short periods of time.

The internal processes for preparing macro-fiscal forecasts are not fully aligned with the budget cycle. Currently, macro-fiscal forecasts are produced only once during the fiscal year, usually in March, as part of the Budget Strategy Paper (BSP), which presents the Federal government’s medium term fiscal strategy. This timing restricts the potential of the medium-term fiscal framework (MTFF) to effectively guide fiscal policy.

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As the budget preparation process starts in January with the issuance of the Budget Call Circular, the latest macro-fiscal indicators are still based on the previous year’s BSP.

Despite possibly substantial economic and fiscal developments since the publication of the BSP, the macro-fiscal forecasts are not revised. This makes budget preparation challenging.

The projections in the BSP differ significantly from budget estimates. In fiscal year 2023, expenditure forecast in the BSP for fiscal year 2022- fiscal year 2024 (published in April 2021) were Rs1,162 billion (1.2 percent of GDP) less than approved in the annual budget statement. In FY24, projections in the BSP for fiscal year 2023-fiscal year 2025 (published in June 2022) were Rs4,988 billion (around five percent of GDP) less than the annual budget statement estimates.

To improve budget credibility, the role of macro-fiscal functions should be strengthened within the Finance Division. The Economic Adviser’s Wing does not assess the accuracy of the macro-fiscal forecasts. To improve the quality of the forecast, it is important to examine past forecast errors and analyse the reasons for these errors.

To improve the budget preparation process, it would be necessary to revise the Budget Call Circular. It is apparent that many other countries, at a similar level of development to Pakistan, and with a similar administrative background, include much more information in their call circulars, and operate a budget process that has a strategic focus as well as including bottom-up elements.

Some weaknesses of the Finance Division include the lack of specialised staff, fragmented management, weak budget contestation, excessive focus on operations rather than policy, lack of coordination of federal-provincial relations, and limited use of IT to support decision making. The report also identified some functions that were missing or substantially under resourced (e.g., tax policy, debt management) and presented some specific proposals for reorganising the various units that comprise the Finance Division.

Another weak area is the lack of effective coordination between the MFPU in the Economic Adviser’s Wing and the Budget Wing. The deputy auditor general supported the World Bank’s findings when he informed the mission that the Budget Wing had little capacity to scrutinise ministries’ budget proposals, most of which were accepted without challenge.

Meanwhile, Pakistan faces a tight fiscal situation, says the International Monetary Fund (IMF).

The Fund in its latest, “technical assistance report-improving budget practices” noted that the ratio of public debt-to-GDP has risen significantly in recent years, growing by around 16 percentage points of GDP between fiscal year 2017 and fiscal year 2023.

This is due to a combination of factors, including weaker-than expected GDP growth, a depreciation of the rupee, the high cost of responding to natural disasters and the pandemic, underperforming state-owned enterprises (SOEs), but also the general challenges in delivering on planned fiscal consolidation.

Concurrently, the proportion of budget revenue consumed by interest payments has doubled since fiscal year 2017 and now stands at 60 percent of tax revenue.

The authorities have the difficult task of converting a primary deficit of 1.3 percent of GDP for fiscal year 2023 into a primary surplus of 0.4 percent of GDP for fiscal year 2024. This goal is predicated on the materialisation of additional revenues from recent measures and significant restraint across all areas of expenditure, while prioritising social and development spending.

The objective in the medium term is to bring down debt below 60 percent of GDP, from 74 percent currently, in line with the Fiscal Responsibility and Debt Limitation Act (FRDLA) of 2005.

In recent years, actual fiscal outcomes at the Federal level have fared worse than the projections. The actual fiscal deficit exceeded the budgeted deficit by 25 percent on average over the period fiscal year 2017-23.

Budget estimates for revenue have consistently been overestimated. The performance of non-tax revenue (against budgeted amounts) has notably deteriorated in recent years, experiencing a year-on-year drop of 53 percent in fiscal year 2019 and 43 percent in fiscal year 2022.

Copyright Business Recorder, 2024