The day the Khan administration took over the reins of government on 20 August 2018 the budget deficit was under 6 percent of Gross Domestic Product (not at a danger level though it required belt tightening) while the current account deficit was a little over 18 billion dollars requiring urgent remedial macro-economic policies.
By the end of the fiscal year on 30 June 2019 - ten months and ten days of the PTI government - the budget deficit had increased to 8.9 percent, well into the danger zone, while the current account deficit was reduced to 13.58 billion dollars.
The budget deficit remains at an unsustainably high level today, projected at more than 8.9 percent in the ongoing year, supported by data released for the first quarter (July-September 2019). The question is whether during the first quarterly review scheduled in December the International Monetary Fund (IMF) team would insist on containing the budget deficit for the current year to 7.2 percent - inaccurately projected for 2018-19 by Pakistan authorities that led to the 12 May staff level agreement - or recalibrate it to 8.9 percent based on actual revised data released in August 2019 by the Finance Division?
The IMF team had cleverly, or so it may have thought at the time, insisted on 115 billion rupees in the budget for contingencies that could be used for any untoward expenditure. Would this amount be sufficient to bridge last year's actual deficit? The budgeted (and the basis of negotiations with the Fund) against the consolidated federal and provincial budgetary operations 2018-19 data released in August 2019 for last year was as follows: budgeted total FBR and other taxes to generate 4,393,876 million rupees (as against actual collection of 4,071,619 million rupees), non tax collection was budgeted at 637,751 million rupees (against actual collection of 363,941 million rupees); current expenditure was estimated at 4,660,613 million rupees (actual amount 4,776,150 million rupees), PSDP at 500 billion rupees (around 2 billion rupees higher than was actually disbursed) giving a budgeted expenditure revenue deficit of around 200 billion rupees (against 822,655 million rupees actual deficit). In other words, the budgeted deficit was around 24 percent less than the August data contends and if the amount earmarked for contingencies is used for this purpose it would still leave to a shortfall of 707655 million rupees higher than was budgeted for last year.
The determined effort by FBR's Chairman to meet the unrealistic tax revenue target this year as pledged by Hafeez Sheikh to the IMF partly accounts for an "over correction" defined as his salutary attempt to bring all those operating outside the legal economy into the tax net this year. A more phased approach may have forestalled the looming threat of strike action and cessation of all economic activity by those operating in several sectors/subsectors, particularly the real estate sector with its consequent impact on 30 downstream industries. This, in turn, is negatively impacting on the already low projected growth rate of 2.4 percent for the current year with a consequent impact on revenue collections.
Given that the FBR target is too unrealistic, and data for the first quarter of the current year indicates this, Hafeez Sheikh is relying on privatisation to generate the funds required to meet the 30 percent raise in current expenditure in the current year (barring the rise in defence) and 40 percent raise in development expenditure. One would hope that the Prime Minister takes serious note of his Advisor's privatisation methodology as none of the three major privatisations during his tenure as Privatisation Minister are without controversy - notably PTCL, K-Electric and Habib Bank Limited.
Governor SBP Reza Baqir was appointed on 6 May 2019 and he is taking credit for the decline in the current account due to his decision to implement two 'prior' International Monetary Fund (IMF) conditions. First, the move towards a flexible market determined exchange rate with a focus on price stability with interventions limited to safeguarding financial stability and preventing disorderly market conditions. Unfortunately, Baqir, perhaps unaware that the rupee was already undervalued by around 3 percent in May, proceeded to further undervalue it by 10 percent in June, which raised the country's foreign repayments dramatically (the loss in value of each unit of rupee against the dollar adds 100 billion rupees to debt). By August the rupee was undervalued by 7 percent. There is no doubt that an undervalued rupee has made imports unattractive and it is import compression that accounts for a significant reduction in the current account deficit. Disturbingly though no attention was paid to the fact that also effected would be our manufacturing sector which relies heavily on import of raw materials and semi finished products. The outcome therefore has been a decline in productivity followed by rising unemployment. Exports on the other hand increased only marginally and there is supporting historical data that indicates little, if any, linkage between an undervalued rupee and a rise in exports though overvaluation during the Dar tenure accounts for a massive decline in exports. The reason is other contributing factors including global recession, losing markets due to an over-valued rupee not easily reestablished with an under-valued rupee, rising costs of production due to rising utility rates, and failure to disburse refunds.
The Saudi 3.2 billion dollar per annum deferred oil facility, which was procured months before Baqir's appointment, has played a significant role in reducing the current account deficit.
Secondly, Baqir raised the discount rate by 150 basis points to 12.25 per cent in May, the second IMF prior condition, which was supported by independent economists though the SBP justification that the decision was taken to address pressure from higher recent month on month headline and core inflation was baffling as the SBP's monetary policy tools have no impact on food and energy prices which is why discount rate in this country was traditionally linked to core instead of headline inflation. However, the further raise in the discount rate in July by 100 basis points is difficult to support as it completely choked off private sector activity. Thus, this over-correction has further choked off private sector activity and raised the government's internal debt repayments from what was budgeted.
To conclude, over-correction in monetary and fiscal policy is not good economics given that it has brought private sector activity to a standstill with major repercussions on inflation and employment levels - the two factors most likely to have major political implications.