The Federal budget for 2021-22 is currently under preparations. The date for presentation to the National assembly has been announced as the 11th of June. This may, of course, be subject to change. The delay may be the result of some lack of clarity on the objectives to be achieved in the forthcoming budget.

There is, of course, the realization that the tradeoff is between achieving more stabilization and fostering higher growth in the economy. The fundamental question is whether there is any ‘fiscal space’, given the current state of public finances? If yes, then this will provide for increasing the size of the PSDP or providing some relief in indirect taxes or extending more fiscal incentives to stimulate investment and thereby create some buoyancy in the growth process.

A more balanced outcome can be achieved if the government debt-to-GDP ratio does not rise in 2021-22 and it still enables adoption of the some of the above-mentioned measures to push up GDP growth. Fortunately, with the sizeable appreciation of the rupee there is the expectation that the government debt-to-GDP ratio will fall from 79.6 percent of the GDP at the end of June 2020 to 77 percent of the GDP by the end of June 2021. This is the projection even if the fiscal deficit approaches 8 percent of the GDP in 2020-21.

However, this could have the opposite effect in 2021-22. The rupee stood at Rs 156 per one US $ in March 2021. It was already somewhat overvalued. According to the SBP, the real effective exchange rate of the rupee was above 100, at 100.5. Now the rupee has appreciated further in April by another 2 percent.

Therefore, the question is whether the appreciation of the rupee will continue in 2021-22? If the rupee starts depreciating during the year, this will add to the rupee value of the outstanding government external debt, which is likely to approach $85 billion by end of 2020-21.

A moderate depreciation of the rupee of 6 percent coupled with a rise in external debt by $5 billion implies that the increase in the rupee value of external debt will be higher by approximately Rs 850 billion. If the level of Government debt is to remain unchanged at 77 percent of the GDP at the end of 2021-22, then the increase in government debt will need to be restricted to Rs 4450 billion, with the projected increase in GDP in 2021-22 of Rs 5787 billion.

The bottom line is that the budget deficit will have to be limited to approximately Rs 3,600 billion in 2021-22. This is equivalent to 6.9 percent of the projected GDP in 2021-22. The Government has estimated in its Medium-term Budget Strategy (MTBS) paper that the projected deficit will be 6 percent of the GDP. However, the budget deficit adjustment which will keep the government debt as a percentage of the GDP unchanged is a reduction of 0.5 percent of the GDP. This is significantly less than the adjustment agreed originally with the IMF of 1.5 percent of the GDP and shown as 1.4 percent of the GDP in the MTBS. Therefore, this approach will create ‘fiscal space’ of 0.9 percent of the GDP, equivalent to Rs 475 billion.

How can this fiscal space be used? There are many legitimate claims. First, the MTBS projects that the total revenues will have to increase by Rs 1608 billion in 2021-22, with a hefty growth rate of over 25 percent. Although not mentioned explicitly in the MTBS, this will require that three-fourths of the increase will have to come from higher FBR revenues. This will represent a growth rate in FBR revenues of almost 27 percent. Given the normal growth in FBR revenues as the economy grows, this will require taxation proposals of over Rs 730 billion.

However, there is another problem. Federal revenues, excluding the FBR revenues, are expected to also grow by almost 21 percent in 2021-22, according to the MTBS. Almost 30 percent of these revenues are expected to come from the Petroleum Levy of Rs 600 billion. But this is based on Petroleum Levy of Rs 30 per liter, which is now down substantially. At current rates, the revenue generated will not exceed Rs 200 billion, implying a shortfall of almost Rs 400 billion.

Therefore, the total revenue from taxation proposals is Rs 1130 billion if the MTBS target deficit of 6 percent of the GDP is to be attained. However, with the higher deficit target, which keeps the debt to GDP unchanged in 2021-22, the requirement of taxation proposals comes down to Rs 655 billion.

A feasible scenario is for proposals in FBR taxes to generate an additional Rs 400 billion and the Petroleum Levy raised to at least Rs 20 per liter during 2021-22. In effect, the target for FBR revenues then will be Rs 5600 billion, implying a more feasible growth rate of 19 percent.

Turning to the expenditure projections in the MTBS, the overall growth projected in Federal expenditure is a modest and feasible 10 percent. Debt servicing is expected to increase by just over 6 percent implying that other Federal expenditure can be raised by over 11 percent. In particular, the MTBS envisages an increase in the Federal PSDP plus lending and other development expenditure of over 21 percent. Overall, the targets set on the expenditure side are of the right order of magnitude. The 21 percent jump in development spending will have a positive effect on growth.

The effort to combine no further increase in the government debt-to-GDP ratio, the prime indicator of stabilization, with relative fast growth in development spending, has the making of the appropriate strategy. It will combine some stabilization with some growth.

The incremental taxation of Rs 400 billion in FBR taxes must come from direct taxes. The tax expenditures in the form of tax breaks and concessions to the ‘elite’ add up to over Rs 1100 billion. Our new Finance Minister will surely attempt to withdraw some of these tax privileges.

The loose end in this strategy is the IMF reaction to deviation from the agreed MTBS. Already, it has been indicated that the Fund will wait till the Sixth Review, due in July 2021, to interact with the government.

The Finance Minister has come out strongly against the exclusive focus on stabilization in the IMF programme, as embodied in the MTBS. Hopefully, he will be able to convince that the path chosen is more realistic, more balanced, and more in tune with economic conditions in Pakistan after Covid-19.

(The writer is Professor Emeritus at BNU and former Federal Minister)

Copyright Business Recorder, 2021