Following the parliament’s failure to take the much-needed steps, the President has ordered measures to be taken to curtail the mounting fiscal deficit within 5.3 percent of GDP.
This can be analogous to the bridge finance facility for fiscal support, availed from the IMF in lieu of the delay in FoDP disbursements. However, its fate beyond a quarter depends upon parliament’s support in the coming budget.
Nonetheless, this is a step in the right direction, which comes after a series of long deliberations between the country’s economic managers and the Fund earlier this month. Political leadership of the ruling party has finally been convinced by the finance minister as regards the horrendous consequences of not fulfilling the IMF conditions.
Mind you, the conditions of the Fund, old and new, essentially come from domestic policy experts who recommend different measures to the Fund’s officials, and the latter, in turn, make those recommendations as conditions for the political leadership.
Two and a half years back, when Pakistan went to the IMF and prepared a programme to implement RGST as a reform process to document the economy, advisors of the Tax Administration Reform Project (TARP) suggested that it is imperative to document the economy for increasing the tax-to-GDP ratio and tame fiscal deficit.
The IMF, whose objective is that the country should have fiscal and financial discipline to safeguard its funding, therefore, started pressing on RGST and other conditions. However, RGST couldn’t follow through due to the dispute over services sales tax between the federation and the federating units.
After a year-long extension sought from the IMF, the last budget promised RGST implementation from November, but could not do so. Now when the provinces are on the same page, the coalition partners have become staunch opponents.
The MQM rightly argues on grounds of equitable taxation system, that agri and real estate income should be taxed first before increasing the burden on the existing urban taxpayers.
Dr. Sheikh, within the federal jurisdiction, attempted to design a midway solution by lifting the exemptions on sales tax of agriculture inputs including fertiliser, pesticides and tractors.
Then is the smart move of keeping GST on sugar at half the rate, but on actual market prices rather than the much lower assumed ex-factory price of Rs28.88/kg. This may create a delicate balance of not hurting consumers as well as producers considerably.
Zero rating on the five export-oriented sectors is restricted to export registered manufacturers cum exporters on export proceeds only. As for their domestic sales, GST will be deducted at factory at normal rates.
This way, the potential conflict of the delay in refunds can subside. However, the withdrawal of exemptions on sales tax on plants, equipment and machinery for export-oriented sectors could only be adjusted through domestic sales, and, if the former is more, refunds have to be made by the FBR.
It will be interesting to see how the next budget deals with measures on GST, as the life of Presidential Ordinances is three months and it has to be endorsed by the Parliament thereafter. This seems like a daunting task in the prevailing political turmoil, as reportedly there is resistance within the party as well. Not to mention other parties are openly criticising the mini budget.
The likely life of other measures, including income surcharge of 15 percent for the last four months of the fiscal year, and the increase in special excise duty by 150 percent is for the rest of the fiscal year.
This step is taken on the basis of showing the IMF some commitment from fiscal side and to bring some sanity on fiscal deficit. The effective tax rate for corporations for FY11, therefore, is going to be 36.75 percent.
The government envisages to raise additional Rs53 billion from all revenue measures to partially compensate expected fall of Rs87 billion from FBR’s budgeted target.
In addition the government has rightly planned to tighten expenditures for the rest of the year by slashing development expenditure, banning fresh recruitment and purchase of durable goods and 50 percent cut in non-salary expenditure.
This is estimated to save Rs67 billion. In total, the fiscal balance is envisaged to improve by Rs120 billion or 0.7 percent of GDP. However, it is unlikely for the government to limit the fiscal deficit to 5.3 percent of GDP and it may reach around 6 percent of GDP.
Reducing the fiscal deficit to a sustainable level is also dependant on reduction of subsidies. The delay in timely rationalising of electricity tariffs has already added to the stocks of circular debt. A hike of two percent every month will impact the flow, and the stock adjustment load will be borne by the budget.
Keeping a lid on borrowing from the State Bank is of paramount importance. Adjusting the existing monetary overhang and firmly resisting fresh money creation will address the very root of our economic mess and help reduce inflation to single digits.