The harrowing deficit tale

The first quarter FY19 deficit raised to an alarming level of 1.4 percent of GDP - highest 1Q deficit since FY11, eluding government revised full year target of 5.1 percent. The worrisome point is that it was a transitory period and development expenditure was also low. The transfers to provinces were too high to take the federal fiscal deficit at 1.9 percent of GDP- highest in decades.

The tax revenue growth stalled as the previous government (MIftah) in its last days presented an unrealistic budget and its implications are visible in first quarter numbers.

The incumbent finance minister (Asad) presented a supplementary on 18th Sep, its effect, if any, would be visible from the second quarter.

Since, most of the time, caretakers were at the helm during the quarter, the unsustainable fiscal framework becomes more visible as there were no accounting gimmick to compress the actual numbers. Yes, the federal government can work on increasing tax revenues, but there is nothing much that can be done to cut current expenditure without passing on due expenditure share (subsidies and BSIP, and debt servicing on these accounts) to provinces to complete the cycle of 7th NFC award and 18th amendment.

The federal share in total consolidated revenues stood at 31 percent in 1QFY19 versus average of 52 percent in the previous four years’ first quarters. There is nothing to talk about provincial own revenues this quarter, caretakers and new government did not withheld provincial share as Dar used to do.

The framework does not allow the government to do much - 79 percent of federal current expenditure was booked in debt servicing, defence and pensions. And provinces have no incentive to curtail their spending - current expenditure of provinces grew by 22 percent in the 1QFY19.

Debt servicing grew by 14 percent to reach Rs507 billion which is 1.5 times the federal revenue net of provincial share (Rs340bn) - one third of debt servicing needs fresh creation of debt. Cost of debt increased this year - domestic part is inflated by 275 bps increase in interest rates while foreign component ballooned by 27 percent currency depreciation. The servicing gets more expensive with further monetary and exchange rate adjustment - it’s a vicious cycle.

Another elephant in the making is pension and superannuation allowance – which grew by 35 percent to take one fourth of net federal revenues. Without creating funds for it, the pension liability may eat half of all governments budget by 2050 - will the sovereign default on its own pensioners?

The fiscal framework in Pakistan was termed unique in the world by IMF in one of its reports. The consolidated fiscal deficit is taken some care by provincial surpluses which were at Rs246 billion (too high as provinces did not get time to spend on development) in the quarter.

The consolidated total revenues and tax revenue increased by mere 8 percent each in Jul-Sep18. The federal direct taxes grew by only 4 percent, reflecting the impact of lowering taxes on individuals. The problem with direct taxes is that in the last two years, too much advance tax was collected from corporate which cannot sustain - the targets are set including advance taxes which is absurd. Lately, the FBR chairman has been telling LTO offices to not demand any further advance tax. There is not much to expect from direct taxes without enhancing base, which remains a pipedream.

The reliance would shift more on indirect taxes as the IMF would push for higher GST rates. The sales tax collection grew by just 7 percent (Rs335bn) in the 1QFY19 - slowdown on economy is adversely affecting it, but contribution at import stage is compensating a bit. The populous decision of not passing on the oil price and currency impact on to petroleum prices is eating the potential along with low sales of HSD.

The silver lining is that oil prices are coming down and that will give room to collect higher tax on petroleum prices without lowering prices too much. Low oil prices will surely help in slashing energy related subsidy and ease the pace of circular debt growth. Custom and regulatory duties are growing at a decent pace; crackdown on money laundering has the potential to boost import duties.

But major share of all these marginal increase in revenues will go to provinces, not helping out in resolving federal crunch. The axe fell on development budget - combined PSDP fell by 35 percent. The development spending is likely to remain low; GDP growth may be compromised in the process.

The only good news to take home from the report card is the change of financing mix towards non-banking domestic sources - the government borrowed Rs238 billion from non-banks versus Rs25 billion in the same period last year. Similarly, foreign borrowing, stood at Rs211 billion versus Rs8 billion last year.

Though foreign borrowing carries exchange rate risk, and other domestic borrowing eats up potential of bank deposits, private sector crowding out may fall.

The banks are enticed to give credit to private sector, and it is reflecting in monetary profile (M2) numbers. Let’s see how long it takes the non-banking sources to exhaust as there is no stopping the financing needs.