Mounting challenges

With the publication of fiscal operations for Q1, the full set of information on economic performance for Q1 is available together with four months data on several variables. What are the key takeaways?
First, the Q1 FY19 is the worst outcome since 2011. Curiously, Q1 is a lean period, as both revenues and expenditures are moderate because the closing of a financial year triggers strong energies to improve books, through revenues, and rush to spend budgeted allocations counter-acted by finance managers panicking to meet end-year fiscal deficit target. A new beginning relaxes nerves and passions subside. Yet, the deficit of 1.4 percent implies (if continued at this pace) a deficit of 5.6 percent for the year, well above the 4.9 percent announced in the Miftah Ismail's budget of April 2018 and 5.1 percent in the Asad Umar's mini-budget of 18 September. Without a major change in economic direction, the deficit is headed in the range of 6.5-7.0 percent. What are the causes of this poor fiscal outcome? At the consolidated budget level, compared to Q1 FY18, revenues growth was 7.5 percent while expenditures rose 12.1 percent (with a much higher base). On the revenues side, tax revenues were up 7.0 percent while the non-tax revenues were up by 11.6 percent. Of this, the FBR revenues saw an increase of a mere 8.8 percent despite having some impact of the amnesty scheme which was extended for the month of July. There was a massive increase of 19 percent in the current expenditure at the federal level and 22 percent at the provincial level, whereas there was an astonishing decline in the combined development expenditure of nearly 50 percent. At the federal level, the leading heads that contributed to higher current expenditures included debt servicing (14 percent) and defense (21 percent).
This is a very weak fiscal performance. The performance of tax revenues for the four months is barely 6.5 percent, down from about 8 percent of the last two fiscal years. The expenditures would continue to rise as interest rates are rising and debt servicing remains the most significant expenditure. The upshot is that the fiscal remains a challenge and hence without fixing it, there is no hope either of getting a Fund programme or stabilising the economy at our own.
If one adds up some of the unrecognized or unbudgeted expenditures in the pipeline, such as circular debt, gas subsidies and the disallowed portion of increase in gas and electricity prices determined by the regulator, the state of fiscal finances would become even more precarious.
Second, the external balance has slightly improved in the first four months, as current account deficit (CAD) declined by about 5pc. This slight improvement owes to remittances, which showed a remarkable growth of 15.14 percent compared to a meager growth of 2.7 percent in the same period of last year. This means the underlying trade balance remains under strain. The need is a major decrease in imports, which is not in sight. In our assessment, we would be out of woods only if we cut the CAD by at least half from its level last year. A CAD of $10 billion or more is unsustainable. But then we are left with eight months to contain the deficit to $10 billion or less. This means the CAD, in the next eight months has to remain below $5.160 billion or $645 million per month or less. This is a tall order of austerity, but without it, we would find it very difficult to finance it at reasonable rates.
Third, the cut in the development expenditure is feeding into economic growth which, undoubtedly, is the need of the hour given an overheated economy. This is reflected in the decline of nearly 2 percent in the large-scale manufacturing (LSM) output (with all key industries - textiles, food and beverages, tobacco, coke and petroleum, fertilizers, chemicals and automobiles registering negative growth) for the second month in a row. Early reports on Kharif crops are mixed and hence overall growth momentum is all set to go south. Fourth, the inflation would be on the rise during the month of November, as both the key prices of petroleum products and electricity were increased during the month and their impact would be reflected in the monthly inflation. There is, however, a good omen developing on the horizon as petroleum prices have nosedived in the last two months. It is difficult to predict their future direction, but clearly a short-term reprieve is in sight. This would have a particularly pronounced effect on the import bill, thus slowing down the import growth or possibly lead to a reduction in value. If there is a downward move on the demand for petroleum products then it would signal a slowing economy. Rising prices and slowing economy are the worst conditions known as stagflation.
Finally, barring the Saudi support of $1 billion, we have received not much support for balance of payments. As we noted earlier, we have continuing BOP challenge in hand.
It is in this backdrop that we need to examine the implications of not having a Fund programme in place and choosing to live with a vulnerable balance of payment (BoP) position. Doing without a Fund programme is a risky venture. It seems, by many statements of senior government officials, that they are not worried about the unsuccessful dialogue with the Fund. Furthermore, it is also said that for two months there is no danger being faced. After Chinese visit, it was claimed that the full year BoP has been covered.
While there may be some comfort for now, or it may extend to some more time, the decision is whether to do a Fund programme or not. There are two options available: (a) you do the programme now at a politically high cost; or, (b) you delay it in the hope that the two months cushion would help avoid those high costs and hope that during this wait period more support would arrive which would allow further delay in the Fund programme.
The correct choice is determined by considering the state of the economy during the wait period. Even though there are some modest gains in various economic indicators (such a slowdown in CAD), the fact remains that the state of economy remains fragile and vulnerable. In our assessment, going forward, these challenges would continue to mount and the cost of doing a Fund programme would continue to rise. Accordingly, our sincere advice, as in the past is to close this chapter as soon as possible so that the bigger challenge of economic revival, growth and employment is taken in hand without worrying about economic stability.
(The writer is former finance secretary)
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