With new Government having Assad Umar as Finance Minister with Economic Advisory Committee based on the same persons who served Musharraf government that brought economic crisis in 2005 with flow of capital outside Pakistan are now trying to cap the inefficiencies and irregularities of the economy. His comrades in State Bank are also the same.
Immediate problems are highly bulged twin deficits i.e. current and fiscal deficits. In fact both are two faces of the same coin.
In simple words look for budget 2018-19. Half of it has been consumed by debt repayments/interest payments plus expenditure on defense. To run the country it needs further borrowing of Rs 2 trillion.
What happens that additional amount brought through fiscal deficit enters in to the market enhancing demand capacity of the market that shifts towards increase in imports creating current account deficit. In simple words this requires raising revenue as well, reducing import and increasing exports. But for that lot of structural reforms are required. In other words to get $ 9-12 billion to smooth out economy if you have to go to IMF than the game of bringing reforms would get in our life with its short term consequences.
Some of our experts say that with changing regional groupings we can get out of economic crisis but in realty this is a world of give and take. From the export/import data it is revealed that we are in advantage only with European countries in export and import business. With China, Far East and Islamic countries we are at significant loss.
The combination of economic activity and low inflation always give two important implications. First, it boosts confidence in the economy, which along with affordable cost of financing induces firms to borrow substantially. In particular, energy, textiles, and cement sectors have focused more on capacity expansion to gear up for growing domestic demand. A healthy rise was also observed in working capital requirements; while the consumer finance posted the highest during the last 12-years, driven mainly by a surge in auto and housing finance. Ample liquidity in the wake of maturity of government securities also supported this credit off-take.
The second impact relates to increase in consumption, which along with recovering oil prices, further inflated the import payments. Higher import bill, despite 10 consecutive months of exports growth and rising workers’ remittances, resulted in record widening of current account deficit. Even higher financial inflows from IFIs, bilateral sources, and issuance of sovereign bonds remained insufficient. Thus, the remaining payment gap fell on the country’s FX reserves, which fell to only two months of import cover in 2018. The foreign exchange market also remained volatile and PKR depreciated from Rs 108 per dollar to Rs 123 per dollar even touching to Rs 130 per dollar.
These external sector developments started to impact inflation as well. The pass-through of rising global oil prices to domestic fuel prices pushed up the energy component of inflation, as the government passed on its impact to consumers. Similarly, the impact of PKR depreciation started to translate into costly imports and shoring up of inflationary expectations.
On the fiscal side, the healthy growth in revenue could not keep up pace with a sharp rise in fiscal expenditure. Particularly, the development expenditure related to infrastructure and power projects increased sharply, with major contribution coming from provinces. As a result, the fiscal deficit in FY 2018 stood higher than corresponding period last year.
To finance the fiscal gap, the government had to rely both on SBP’s borrowing and external sources. External debt, owing both to higher commercial loans and revaluation impact of the PKR depreciation, also rose considerably.
In short, ensuring the continuity of expansion in economic activities and low inflation would depend on containing of current account and fiscal deficits. As these vulnerabilities are posing challenges to Pakistan’s current growth cycle, implementation of both short-term and medium term policies would be crucial in this regard.
In short-term, concerted efforts could be made to rationalize fiscal expenditures by increasing tax net not on the basis of withholding tax on banking transactions or sale purchase of property. For this tax legislation is required for services sector, Agriculture sector, Whole sale and Retail sector with bringing reforms in FBR i.e. to ask it to raise direct tax by using NADRA data. In the medium term, reforms would be needed to expand tax base besides enhancing efficiency of the existing system. Simultaneously, there is a need to arrange external financing in the short term. Also, more policy measures are required to contain the widening trade deficit. For this purpose, it is also crucial to resolve structural issues affecting exports competiveness.
The slowdown in revenue collection was primarily due to direct taxes. More specifically, the drag came from a decline in voluntary payments, while withholding taxes and collection on demand increased considerably compared to last year. The decline in voluntary payments can partially be attributed to reduction in corporate tax rate (It is reported that due to such rates corporate sector conceal 60% of its taxable income) and lower bank profitability. Meanwhile, growth in indirect and provincial taxes remained buoyant in line with expanding economic activity, and the pass-through of rise in the oil prices to domestic consumers. The non-tax revenue also recovered strongly, bolstered by a jump in provincial non-tax revenue, higher markup payment, dividend income and PTA /postal service profit.
The acceleration in growth of expenditures was more due to higher provincial spending, with both current and development expenditures growing sharply. The provincial development spending grew by 36.7 percent during Jul-Mar FY18 compared to 13.6 percent in the corresponding period of last year. Growth in federal development spending also remained high, close to 25 percent compared to 28.9 percent in last year. The push has come from urgency to complete the ongoing project before the terms of assemblies came to an end. Similar to growth in development expenditure, major contribution to a sharp increase in current expenditure came from provinces, especially in Q3-FY18. Higher debt servicing and defense spending at federal level and general public services, economic affairs, and public order and safety in case of provinces contributed to the increase in current expenditures.
The resulting higher fiscal deficit was largely financed through borrowing from SBP and external sources. In case of external financing, government heavily relied on commercial loans and sovereign bonds. Moreover, the revaluation losses, resulting from appreciation of major currencies against US$ and the depreciation of rupee against US$ also added significantly to external debt. Overall, these developments led to considerable increase in public debt, with record accumulation.
The government has set a 6.2 percent real GDP growth target for FY19 largely on the back of accelerating growth momentum of the last few years. Higher PSDP and CPEC spending, a further ease in power supply, and continuation of industrial expansion plans, are other reassuring factors. However, the growing external vulnerability and high fiscal deficit will continue to pose major down side risks to the achievement of this target. Moreover, on the real side, the ongoing dry spell and water shortages may adversely impact the value addition potential of the agriculture sector.
High domestic demand, lagged impact of adjustment in energy prices, and PKR depreciation are likely to contribute to higher CPI inflation in FY19. Smooth supply of staple food items and soft oil price on the other hand could offset these underlying pressures and help keep inflation around the target of 6 percent set for FY19.
The government has set fiscal deficit target at 4.9 percent of GDP for FY19, which is based on a 12.7 percent anticipated growth in FBR tax revenues and a 10.0 percent increase in expenditures, with greater emphasis on current expenditure. While the current budget has reduced tax rates without rationalizing expenditure, achieving the fiscal deficit target in this backdrop appears challenging.
On the external side, the exports growth prospects remains encouraging on the back of PKR depreciation; recovery in global demand; fiscal incentives for exports; ease in power supply; and improved price outlook of rice and cotton in the international markets. Also, the growth in workers’ remittances is expected to further gather some pace, partly on account of the steps taken by the government and SBP to attract inflows through the official channels. At the same time, a deceleration in imports is expected due to PKR depreciation and the continuation of administrative measures to dampen the domestic demand for non-essential import items.
However, the import bill is likely to stay high owing to a notable increase in international commodity prices, especially of oil. This would keep the trade deficit high in FY19 as well. Furthermore, the FDI inflows are expected to remain lower in FY19 than last year as a number of CPEC energy projects are in their advance stages of completion. Therefore, in overall terms, the high current account deficit, together with limited financial inflows, would continue to keep the balance of payments under pressure.
The latest figures negate the federal government’s claim that it has reversed the trend of last fiscal year when the budget deficit peaked to a historic high of Rs1.863 trillion or 5.8% of GDP.
The Rs1.481-trillion deficit suggests that even the revised annual target of 5.5% of GDP or Rs1.891 trillion will be breached.
Hence from a fresh slate government has to do its work that with the present team looks not likely to happen. So Government should bring a formidable team not based on already tried persons.
Chairman Centre of Advisory Services for Islamic Banking and Finance (CAIF), former Head of FSCD SBP, former Head of Research Arif Habib Investments and Member IFSB Task Force for development of Islamic Money Market, former Member of Access to Justice Fund Supreme Court of Pakistan.