Budgetary outcome in 2019-20

The Mid-term Budget Review of 2019-20 was presented recently to the National Assembly. The outcome in the first six months reveals success in limiting the primary deficit and achieving the target agreed with the IMF. In fact, a primary surplus has been achieved of 0.6 percent of the GDP with the overall budget deficit at 2.3 percent of the GDP.

A number of questions arise regarding the fiscal operations by the Ministry of Finance. How has the target for deficit reduction been achieved when there has been a significant shortfall in tax revenues? What is the fiscal outlook for the whole year of 2019-20? Does the Budget Review make an accurate and unbiased forecast of the likely budgetary outcome for 2019-20? In which budgetary magnitudes is there likely to be significant divergence from the original targets in the Budget presented to the National Assembly in June 2019?

The performance criterion on the ceiling to the size of the primary deficit for December 2019 was met by, first, a big jump in the profits of the SBP to Rs 426 billion, equivalent to over 104 percent of the projected annual profits. This more than compensated for the shortfall in FBR revenues. Second, development spending was restricted to 35 percent of the annual budgeted amount.

Despite this success in the first six months, the Ministry of Finance has highlighted a number of risks in meeting the annual target for the fiscal deficit of 7.5 percent of the GDP in 2019-20 and the primary deficit target of 0.6 percent of the GDP agreed with the IMF. Five risks have been identified.

These are, first, a substantial shortfall in tax revenue. Second, there may be unexpected volatility in the exchange rate. Third, the losses and circular debt in energy sector could increase the burden on the budget. Fourth, there could be a faster rise in pension expenditure and liabilities and, fifth, unexpected increase in the public debt and problems in financing of the fiscal deficit.

Therefore, the MoF is conveying the message to the National Assembly and the IMF that the primary deficit is likely to rise above the ceiling imposed in the performance criterion of 0.6 percent of the GDP for 2019-20. The fundamental question is what will be the budget and primary deficits in 2019-20?

The first issue is the expected level of FBR revenues in 2019-20. According to the latest figures of eight months, July 19 to February 2020, they have reached Rs 2,702 billion, demonstrating a growth rate of 16 percent. If this growth is maintained over the next four months then the full-year revenues could reach Rs 4,400 billion.

However, there are one or two positive developments which could yield higher revenues. First, there is the precipitate fall in the price of oil. If half of the benefit is retained by the Government in the form of a higher Petroleum levy, then additional revenues of Rs 90 billion could accrue in the last quarter of 2019-20. Second, if the recent decline in the value of the rupee persists then import based revenues could be higher by Rs 30 billion. As such, a likely level of federal tax revenues, including other taxes, in 2019-20 is Rs 4,745 billion.

The revised target for overall tax revenues is Rs 5,505 billion. As such, the shortfall is likely to be as large as Rs 748 billion. This is equivalent to 1.7 percent of the expected GDP in 2019-20 and will be the largest shortfall ever, attributable to the extremely ambitious target. It alone will take up the fiscal deficit to 9.2 percent of the GDP.

The question then is where does scope exist for cutting back expenditure? There are indications already that the PSDP will be cut back by Rs 100 billion. Also, the outlay on social protection and on the BISP may be lower due to implementation capacity constraints by Rs 150 billion. Total savings of up to Rs 250 billion could be realized, equivalent to 0.6 percent of the GDP.

Therefore, the first estimate of the budget deficit in 2019-20 is 8.6 percent of the GDP. The corresponding estimate of the primary deficit is 2.1 percent of the GDP. This is 1.5 percent of the GDP above the target agreed with the IMF. Therefore, the prospect is that from the third quarterly review onwards by the IMF staff there will be a violation of a key performance criterion and need for a waiver from the Executive Board of the IMF.

What will be the impact of the other risk factors? The biggest risk relates to the large and growing circular debt of the power sector. There will be a need to inject liquidity into the sector. Already, there is a proposal for floating a Sukuk Bond of Rs 200 billion to reduce the circular debt. Meanwhile, the volume of this debt will continue to increase due to deferment of the tariff increase.

The other area of concern is the financing of the deficit and the magnitude of debt service payments. The budget had targeted for 58 percent of the financing of the budget deficit with relatively low cost external borrowing. During the first six months, the contribution of external financing has been 52 percent. Further, the larger deficit will imply more interest payments. The additional burden of debt servicing in 2019-20 can only be countered by a significant drop in the policy rate in the forthcoming monetary policy statement.

Overall, there is a fairly high probability that the federal budget deficit could be significantly higher than the targeted level of 8.1 percent of the GDP. Further, the provincial governments are expected to generate a cash surplus of 0.6 percent of the GDP in 2019-20. But will this happen when there could be a shortfall in budgeted transfers to these governments of almost Rs 450 billion?

The bottom line is that the consolidated budget deficit could reach 9 percent of the GDP in 2019-20. This will be a new record level. In these circumstances there will be even greater pressure from the IMF to come up with a very strong budget for 2020-21 with massive additional taxation exceeding Rs 900 billion. This could be the last straw on the camel's back.

(The writer is Professor Emeritus and former Federal Minister)