The government of Pakistan' second 'mini-budget' supports exports, but increases fiscal consolidation challenges in the absence of further revenue-raising measures, says Moody's Investors Services. Moody's in its latest report on Pakistan states that on 23 January, Pakistan's (B3 negative) Finance Minister Asad Umar announced the government's second 'mini-budget,' which largely focuses on revenue-based measures to improve supply-side conditions for businesses and incentivise domestic reinvestment. If effective, the measures will support Pakistan's manufacturing sector, fostering exports and import substitution, and help narrow the current-account deficit.
In the absence of new spending cuts or revenue-raising measures, however, these measures will keep Pakistan's budget deficits wider for long, potentially eroding the credibility of government efforts to achieve fiscal consolidation, maintained the report.
Compared with the government's first 'mini-budget' in September 2018, which emphasized spending cuts, the second 'mini-budget' aims to improve business conditions, including for manufacturers and exporters, by removing or reducing existing taxes that erode profit margins or disincentivise reinvestment. Specific measures include reductions in import custom duties on essential raw materials and machinery, the abolition of tax on retained earnings, and incentives for the agriculture sector, which accounts for around 20 percent of the country's exports.
Moody's further stated that while the 'mini-budget' will support the export sector, there is a greater risk of fiscal slippage and slower fiscal consolidation in the absence of further revenue-raising measures. Pakistan's revenue base was a narrow 15.4 percent of GDP in fiscal 2018, which ended June 2018.
The government presented limited revenue-raising measures, primarily taxes on large vehicles and high-end mobile phones. As a result, the 'mini-budget' places greater weight on improvements in tax administration and spending restraint for the government to meet its deficit target of 5.1 percent of GDP.
"We expect the deficit to widen to 6 percent of GDP in fiscal 2019 because revenue growth is likely to be below government projections, given slower economic growth and the new revenue based incentives, before gradually narrowing to 5 percent of GDP by fiscal 2021 as the economy picks up. While we believe the government remains committed to fiscal consolidation, a wider for longer deficit could raise questions over the credibility of its fiscal policy," says Moody's.
The 'mini-budget' comes against a backdrop of low export growth in the first six months of fiscal 2019, despite the Pakistani rupee's 25 percent decline against the US dollar since December 2017. The government is seeking to narrow the current-account deficit by reducing some of the tax distortions exporters' face.
Weak exports aside, Pakistan's current-account dynamics have been largely positive in recent months. Remittances rose by 10 percent year on year in US dollar terms in the first half of fiscal 2019, while goods imports slowed sharply to around 3 percent year on year as non-fuel goods imports contracted. However, although Moody's expects the current-account deficit to narrow to 4.7 percent of GDP in fiscal 2019 and to 4.2 percent in fiscal 2020 from 6.1 percent in fiscal 2018, it will remain sizable and wider than in 2013-16, driving Pakistan's external financing needs.
The report further states that the government has secured $12 billion in financing from Saudi Arabia (A1 stable) and the United Arab Emirates (Aa2 stable) - in each case amounting to $6 billion and divided equally between deposits and deferred oil payments - which is likely to largely cover the country's net financing needs for fiscal 2019. However, a net financing gap beyond fiscal 2019 remains because of the still sizable current-account deficit.
Pakistan remains in negotiations with the International Monetary Fund (IMF) over a new programme that would provide a stable additional source of external financing as well as technical support and assistance on macroeconomic rebalancing and structural reform policies, the report further states.
The country is also in discussions with other countries and multilateral lenders such as China (A1 stable), Qatar (Aa3 stable), the Asian Development Bank (Aaa stable), the IBRD (World Bank, Aaa stable) and the Islamic Development Bank (Aaa stable) over external funding support to shore up its external position, maintained the report.
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