The twin deficit problem is ringing alarm bells yet again. Current account deficit soared to 4 percent of GDP while fiscal deficit stood at 5.8 percent of GDP for FY17. The numbers were 8.2 and 7.3 percent respectively in FY08. A decade ago, record high commodity prices triggered the twin deficit, while today prices are much lower - average oil prices in FY08 were 2.2 times of that in FY17.
Today, the deficit is purely demand driven - current account is based on high imports because both public and private sector demand is booming. In case of fiscal, public demand, primarily provincial development spending, is the driver. This calls for immediate policy tightening to avert the inflationary trend.
The Ministry of Finance recently released full year fiscal accounts; and not to the surprise of many, the consolidate deficit slipped by 1.6 percent of GDP to 5.8 percent of GDP from the revised target. Mind you, budgeted target was 3.8 percent which was revised down to 4.2 percent of GDP in June.
Why such a heavy slippage? The reason is simple, provinces failed to show the surplus as was envisaged by federal government. The surplus was budgeted at Rs339 billion which was revised down to Rs290 billion. On the contrary, provinces registered a deficit of Rs163 billion. The gap stood at Rs453 billion or 1.4 percent of GDP; this explains 90 percent of actual fiscal deficit deviation from the revised numbers.
What power does the federal government posses to curtail the deficit? These are the so called fruits of unplanned 18th amendment and 7th NFC award where the revenues are shifted to provinces while major responsibilities still lie at federal level. The need is to seriously think of the problem in designing 8th NFC award which is already due. Fiscal responsibilities ought to be shifted towards provinces to make them accountable for their acts.
The ground reality is that federal government does not have much in hand to curtail deficit. The consolidated deficit remained low in the previous few years because provinces kept on showing surplus for straight four years (FY13-16). They had accumulated cash surplus of Rs358 billion in the past four years; and now close to election, everyone is on a spending spree.
Provinces cannot borrow much for fiscal support and their game plan seemingly was to accumulate cash in early years and spend close to elections - this theory implies there would be even higher spending in FY18. And here goes the hopes of managing 4.1 percent consolidated fiscal deficit for FY18.
The opposition governments in Sindh and KPK would like to damage federal government fiscal report card close to elections, while Punjab would want to spend to remain in the race. Punjab being the biggest province showed a marginal deficit of Rs5 billion. KPK and Sindh toll stood at Rs75 billion and Rs61 billion, respectively. Even in FY16, it was Punjab that showed Rs101 billion surplus to undo the Rs74 billion deficit posted by Sindh.
There is not much deviation of both revenue and expenditure side for federal government from the revised figures - tax revenues stood at Rs3.37 trillion as against the revised target of Rs3.5 billion - gap of 0.5 percent of GDP. In case of non tax revenues, the gap is mere Rs10 billion as final toll stood at Rs902 billion. The federal government did a good job in curtailing the expenditure too.
The bottom line is that provincial budget balance is driving the deficit and the problem is political and there has to be a political solution to it. The need is to curtail both public and private spending demand. Federal government should check its PSDP spending; although it is tough doing so in an election year.
And as mentioned earlier in this column, petroleum consumption should be checked through higher prices. The best way is to enhance petroleum levy as the tax collected from the head is not part of divisible pool and may help curtail consolidated deficit apart from curtailing demand. Monetary tightening is also becoming imminent and the SBP should increase the interest rates by 50-100 bps in the upcoming policy review later this month.