The core of the macroeconomic problems is fiscal slippage, while the external deficit is primarily an effect. The issue cannot be resolved by providing symptomatic relief on 'effect' without addressing the cause. The economic indicators of the country suggest that slippage in fiscal deficits is followed by higher current account deficits and it is happening again.
The consolidated fiscal deficit is going to be over $20 billion (6.2-6.4 % of GDP) in FY18 and it is putting pressure on current account deficit which is likely to be around $16-17 billion. The short answer to arrest twin deficit problem is to capture the rising trend in fiscal deficit.
However, it is a difficult proposition today. In 2008, the crisis due to a shock and was easier to fix. Unlike, this time, the structural changes took place after 7th NFC award and 18th amendment, the fiscal space at federal level is significantly limited to lower the deficit without integrated fiscal and economic planning at both federal and provincial levels.
The country will soon be knocking the IMF doors for another bail out. The question is how welcoming would the IMF be as the list of countries eyeing the IMF is growing and the US influence on the Fund might refrain it from generous bailouts. The IMF's appetite, after offering $50 billion package to Argentina, may reduce for other countries.
What kind of conditions and structural changes can the Fund ask, in case of bailing out Pakistan is the big question. There is little doubt that the top priority of the IMF would be fiscal adjustments.
Taking a cue from the IMF report published last year which did not get enough media attention as Nawaz Sharif disqualification was the hot topic then, the focus would be on passing expenditure responsibilities to provinces to compensate for higher share of revenues after 7th NFC award.
"Pakistan fiscal system is somewhat unique compared to other countries", lamented the Fund. The report compared Pakistan fiscal case with OECD countries where all the countries’ provinces (or states) share in general government expenditure is higher than their respective share in revenues (see figure).On the flip, provincial share in general government expenditure stood at 35 percent in FY16 in Pakistan whereas their share in revenues is higher - about 50 percent.
The Fund is clearly not comfortable with current revenue and expenditure mix and the prime objective would be correct the fundamental flaw in the fiscal federalism. The question is what can the IMF propose adhering to the constitutional changes took place in 2010-11.
The 18th amendment ensured that provincial share in divisible cannot be reduced in subsequent NFC awards. The provinces need to be more responsible having attained adequate fiscal autonomy. The provincial share in divisible pool increased from 47.5 percent in FY10 to 57.5 percent in FY12 and that has significantly changed the whole fiscal framework equation.
The problem is that the responsibility factors for provinces as prescribed in 18th amendment are yet to be adopted. The effective role of institutions like eight members council of Common Interest (CCI) and twelve members National Economic Council (NEC) is imperative for formulating plans with respect to financial, social and economic policies to ensure balance development and regional equality.
Unfortunately, due to political polarity amongst political parties in power at provincial and federal levels, these institutions efficacy is missing. One of the conditions could be to have a strong parliamentary secretariat of the CCI to ensure at least one CCI meeting in ninety days and at least two NEC meetings every year. Plus, there is a need to ensure 18th amendment prescription of provincial government to devolve political, financial and administration responsibilities to the local governments (Article 140A).
Above mentioned reforms are soft and may take time to implement; however, the Fund may desire immediate fiscal consolidation to secure its loan repayment. The IMF must be looking at options on increasing flexibility of the fiscal framework.
Today, the federal government is responsible for unexpected expenditure needs of national importance and to assist provinces in times of natural disasters; but nothing of sort happens the other way round. The IMF may opt for a contingency fund to enhance the fiscal framework's ability to absorb large and unexpected shocks to expenditure of national importance.
In order to attain macroeconomic stability, it is imperative for reducing consolidated fiscal deficit and to do so, the Fund might come up with a contingency fund to put aside from revenues before going into the federal divisible pool.
According to the IMF, provinces do not have the incentive to raise their own revenues as long as they get higher share from federal government. While the center, does not have incentive to enhance revenues, apart from sources which are not part of divisible pool such as Petroleum Levy and Gas Infrastructure Development Cess.
Moreover, coordination of various tax collecting and implementing agencies at provincial and federal level is resulting in not only higher taxation burden but also enhances compliance cost for businesses. This is adversely impacting the score on ease of doing business. For this, formation of a National Tax Commission could be a condition or recommendation.
The Fund is seeing a structural flaw as provinces are running cash surpluses while the federal government is increasing public debt to finance its need; as from federal share in revenues the expenditure of debt servicing, defence spending and meeting pension liabilities are not even fully met.
Rest of everything is financed by accumulation of debt. This partially explains why the public debt ballooned after the 7th NFC award. There could be a mechanism recommended to share the public debt expenditure with provinces. One way recommended by the outgoing government is to pass electricity losses to provinces. Times are tough, let's see what does the Fund offer and how the polarized provincial governments react.