Rising fiscal deficit

There has been some concern about the rising consolidated fiscal deficit of the federal and provincial governments combined of Pakistan. During the last five years, the best year was 2015-16 when the deficit was successfully restricted to 4.6 percent of the GDP. This coincided with the last year of the IMF programme.
Since then it has risen sharply to 5.8 percent of the GDP in 2016-17. The fiscal discipline that was apparently on display during the tenure of the Fund Program has given way to profligacy in expenditure and a slackening of fiscal effort in raising tax revenues.
The budget for the current year was based on a return to judicious fiscal management. The consolidated deficit target has been set at 4.1 percent of the GDP. This is based on an ambitious growth rate of 17 percent in federal tax revenues and comparatively moderate growth in expenditure of 6 percent. Provincial governments are also expected to restrain the increase in their spending and generate a combined cash surplus of Rs 347 billion, equivalent to almost 1 percent of the GDP.
However, there are a number of factors which could operate against this outcome. First, 2017-18 is the pre-election year and constituency based politics is likely to be at its peak. This is bound to put pressure on the level of development spending, both at the federal and the provincial levels. Second, the budget presented to the National Assembly was relatively soft with few taxation proposals. With inflation operating at a very low rate of 4 to 5 percent it was clear from the start of the year that anticipating a growth rate in tax revenues of 17 percent was perhaps unrealistic.
How has the year unfolded in the first eight months, up to the end of February 2018? The information on fiscal operations for the first six months already has been released by the Federal Ministry of Finance.
The consolidated deficit from July to December is estimated at Rs 796 billion, equivalent to 2.2 percent of the projected GDP for the year. This is somewhat lower than the deficit in the corresponding period of 2016-17 of 2.5 percent of the GDP. The annual reduction targeted in 2017-18 in the deficit is much larger at 1.7 percent of the GDP. Therefore, there are first indications already that the actual deficit in 2017-18 will be significantly larger than 4.1 percent of the GDP. Normally, the deficit in the second half of the year is significantly higher than in the first half, on average by about 50 percent. On this basis, the projected deficit in 2017-18 is 5.5 percent of the GDP.
The objective of this article is to make a first estimate of the deficit up to the end of February 2018. This will indicate if the pace of deficit creation has accelerated or slowed down since December 2017. The approach adopted is the 'below the line' process of estimation of the fiscal deficit. This involves estimation of borrowing to finance the deficit. Sources of borrowing are both domestic, bank and non-bank, and external. The sources of data include SBP and the Economic Affairs Division of the Government of Pakistan.
The estimate of the consolidated deficit from July to February is Rs 1331 billion. This includes Rs 792 billion of domestic borrowing and Rs 539 billion of external borrowing. The former consists of Rs 540 billion of bank borrowing and Rs 252 billion of non-bank borrowing.
A number of worrying trends are revealed by the estimation exercise. First, within the domestic bank borrowing there has been exclusive reliance on the SBP of Rs 952 billion, while the retirement of debt with commercial banks is Rs 412 billion. Borrowing from the SBP is tantamount to 'printing of money'. This will have an impact on the rate of inflation with a time lag. This practice was largely avoided during the tenure of the IMF programme.
However, this means that there is no 'crowding out' of the private sector from credit by commercial banks. But it is a matter of some concern that despite this opportunity, credit to the private sector has declined by 3 percent. A new competitor has emerged in the form of borrowing by public sector enterprises (PSEs), mostly those which are loss-making, largely with guarantees by the Federal Government. Credit to PSEs has increased by 11 percent up to 9thMarch 2018. Currently, the stock of debt of PSEs stands at a perhaps unbelievable Rs 955 billion.
Second, almost 42 percent of total Government borrowing up to February is in the form of external borrowing. The budget had anticipated a share of 35 percent of such borrowing in total financing. In fact, at Rs 539 billion, the quantum of net external borrowing has already exceeded the projected annual magnitude in the budget of Rs 511billion. Clearly, the pressure is more to finance the current account deficit in the balance of payments. This has resulted in resort to the creation of high cost external debt. Almost 62 percent of the external borrowing by the Federal Government in the first eight months has been in the form of either Euro/Sukuk bonds or loans from international commercial banks. This is already equivalent to 214 percent of the annual target for such financing.
Third, the inflow into National Savings Schemes has fallen sharply by 31 percent. Nominal interest rates have been brought down sharply in line with the fall in the rate of inflation. At its peak, Behbood certificates, which are meant primarily for widows, senior citizens and pensioners, gave an annual rate of return of 16.8 percent. Now it is down to only 9.4 percent. There is a strong case for enhancing the return on the various schemes to encourage household savings.
Overall, at Rs 1331 billion, the estimated consolidated deficit from July to February of the current fiscal year is equivalent to 3.7 percent of the GDP, almost 90 percent of the annual target. This implies a quickening in the pace of deficit creation. It took the first six months to reach a deficit of 2.2 percent of the GDP. Thereafter, in the next two months alone it has increased further by 1.5 percent of the GDP. In effect, the monthly deficit has jumped up by over 108 percent.
This does not auger well for the budgetary outcome in 2017-18. At the current rate of borrowing, the deficit is likely to significantly exceed 6 percent of the GDP, perhaps even approach 6.5 percent of the GDP. The pressure for increased spending is demonstrated by two indicators.
First, releases for development spending at the Federal level were Rs 319 billion up to December 2017. By mid-March, they have increased further in less than three months by another Rs 219 billion. At this rate, the shortfall in relation to the budgeted size of PSDP for 2017-18 of Rs 1001 billion may not be large. Already, releases of 100 percent of the annual allocation have been made to the Prime Minister's Special Programmes and other programmes of pork barrel nature. Secondly, the cash surplus of the Provinces combined was Rs 247 billion in December. It has since fallen to Rs 206 billion. This again indicates a faster rate of spending.
Overall, the outlook for fiscal operations in 2017-18 is for a consolidated budget deficit of over 6 percent of the GDP, substantially in excess of 4.1 percent of the GDP target. It is also likely to be higher than the government's own projection at this stage of 5.5 percent of the GDP and the IMF's expectation of 5.4 percent deficit.
The profligacy in spending is raising the level of aggregated demand in the economy and contributing thereby to more imports and a higher current account deficit. The task for prudent conduct of fiscal policy will have to be left to the new government which is inducted into power after the next elections.
(The writer is Professor Emeritus at BNU and former Federal Minister)