State of provincial finances

The four provinces are the constituent units of the Federation of Pakistan. Their importance has increased substantially following the 18th Amendment to the Constitution, which led to the abolition of the Concurrent List of functions. The provincial governments are responsible for the delivery of basic economic and social services like law and order, justice, irrigation, transport, education, health, water supply and sanitation. There is, therefore, a strong relationship between the state of Provincial finances and the level of productivity and quality of life of the people.
The 7th NFC Award took major steps forward in transferring more resources from the Federal level to provincial governments by enhancing the vertical share of the latter from the Divisible Pool of taxes. Simultaneously, multiple criteria were introduced in the horizontal sharing formula to ensure greater fiscal equalisation between the relatively backward and the more developed Provinces.
The information on Fiscal Operations has been released recently for the first half of 2016-17 by the Federal Ministry of Finance. The basic question relates to the current fiscal status of the four provincial governments combined and respectively of each government.
The major developments between July and December 2016 are discussed below:Transfers from the federal government have actually declined
For the first time since the 7th NFC Award, the total transfers to the provinces have declined, by 2%. This is despite the expansion in the size of the revenues in Divisible Pool by almost 6%. There is a big decline in federal grants and loans of 48%, in relation to the amounts in the first half of 2015-16.
Why has this decline occurred? The answer lies in the deterioration in the state of federal finances which have already posted a fiscal deficit of 2.7% of the GDP in the first half of 2016-17, compared to the annual deficit target of 4.8% of the GDP. The basic reason is the relatively poor performance of FBR revenues, with a growth rate of only 6% compared to the target increase of 16% in 2016-17. Further, almost Rs 65 billion of releases have been withheld by the federal government, thereby leading to an absolute decline in transfers to Provincial Governments. This has contributed to reducing the federal fiscal deficit as of end-December 2016. However, this has impacted adversely on the fiscal position of Provincial Governments.
Own-revenue mobilisation by the provinces has been exceptional Fortunately, a strong fiscal effort at the Provincial level in generating more revenues from own revenue sources has at least partially compensated for lower federal transfers. Provincial tax revenues have grown fast by 19% in the first half of 2016-17. All four provincial governments have demonstrated a high level of fiscal effort. This growth rate is more than three times that achieved at the Federal Level.
The prime example of success is the generation of additional revenues of 30% by the broadening of tax base of the sales tax on services, especially by the governments of Punjab and Sindh. Already, this tax, which was transferred to the sub-national level by the 18th Amendment, accounts for 52% of total provincial tax revenues. A similar effort is required from the Provincial Governments in development of direct taxes under their jurisdiction, like the urban immovable property tax and the agricultural income tax.
Current expenditure has exhibited high growth Here the contrast is in favour of the federal government. Current expenditure at the federal level has increased by only 2%, while the corresponding expenditure of the four provincial governments combined has gone up by 15%. In the case of Khyber Pakhtunkhwa the increase is as much as 26%. Salaries have been enhanced less, by 10%, in the Budgets of 2016-17. Clearly, there is need for the Provinces to show greater economy in current expenditure.
Development Spending needs to be enhanced The target size of development spending by the four provinces combined is Rs 875 billion for 2016-17. The actual spending on PSDP projects in the first six months is Rs 247 billion, only 28% of the annual target.
Issues of absorption capacity are visible in Balochistan where development spending has fallen by 53%. However, the two provincial governments of Sindh and Khyber Pakhtunkhwa have shown big increases of 42% and 46% respectively. PSDP spending in Punjab has remained unchanged, with a share of 57% in total development expenditure at the Provincial level.
Cash surplus of provinces is much below the target Given the fall in revenue transfers and big increase especially in current expenditure, the provincial governments have generated a combined cash surplus of Rs 91 billion, This is small in relation to the annual target of as much as Rs 339 billion.
The likelihood of a large cash surplus by end-June 2017 is low given the slow growth in FBR revenues and, consequently, in transfers to provincial governments. Also, following the end of the IMF Programme and approaching elections next year, it is highly unlikely that large cash surpluses will be produced by Provincial Governments so as to contain the consolidated fiscal deficit. The overall fiscal deficit in 2016-17 will be much larger than the targeted level of 3.8% of the GDP.
Implications for the 9th NFC The share of provinces in the tax revenues generated by the Federal Government has fallen from 61% in 2010-11, the first year after the 7th NFC Award, to 55% by 2015-16. Further, the share of provincial governments in total public expenditure has remained low at 35%, despite the performance of additional functions after the 18th Amendment.
The terminal year target for 2014-15 of the 7th NFC was to raise the share of provincial governments to 45%. Also, in India, the share of States in total expenditure is as high as 55%. Therefore, there appears to be the case for enhancement by the 9th NFC of the vertical share of the Provinces from the Divisible Pool in the next Award, subject , of course, to improved delivery of basic social and economic services.
Overall, the first six months of 2016-17 have witnessed a 'financial squeeze' of provincial governments. This is due not only to low growth in federal tax revenues but also because of delays in releases. The 9th NFC Award needs to be finalised by June 2017 in order to sustain and improve the state of provincial finances.
(The writer is Professor Emeritus and former Federal Minister)