Economy and federal budget

While the budget has been rushed through the parliament once again this year, as usual, it does not decrease the significance of a comprehensive analysis of the budgetary measures taken up by the government, particularly considering the incessantly grave situation faced by Pakistan's economy.
The presentation of annual budget implies, and it needs to be emphasised in the outset, that this essential exercise is not merely a statement of statistics in terms of income and expenditures. More importantly, it presents an opportunity to the government to spell out its vision, intentions and strategy towards facing the challenges in immediate and long-term perspectives. The budget for the fiscal year 2011-12 was the fourth consecutive annual budget presented by the current 'elected' government, and it was expected that with the four-year experience of managing the economy, the Pakistan Peoples' Party-led coalition government would be able to bring out planned policy measures, especially in the context of extraordinary situation and daunting challenges faced by the country. such as unprecedented and unabated energy crisis; extraordinarily damaging floods of monsoon 2010; the ever aggrandising external and internal security threats; the alleged corrupt practices of the high-ups in the government; the questions being raised about its competence, approach, and management style and commitment of its economic managers to the country and its economy in the backdrop of their association with the International institutions and their personal stakes outside Pakistan.
The Federal budget 2011-12 is devoid of short-term, medium-term and long-term strategies corresponding to the current situation of Pakistan's economy which are necessary to devise and implement to meet the challenges head-on. The whole exercise seems to have focused on juggling with figures and budgetary targets of the last year. Considering the economic indicators, the facts and figures as well as measures announced in the budget do not seem to be any indication of the realisation of the looming economic crisis. The most disturbing dimension of the budget is, therefore, a 'deficit of vision'.
Stagflation is one of the key problems faced by the Pakistan's economy. Growth has almost been stalled; even the figure of 2.4% growth is overestimated, as growth recorded in sub-sectors of economy does not translate into an overall growth of this rate. Inflation being exceedingly high is indeed a major problem, yet it needs to be realised that lack of growth is even more intimidating. Pakistan can only come out of crisis if the growth starts picking up again. Keeping the discount rate as high as 14% under successive monetary policy statements has not helped in arresting the rate of inflation. A major reason is that inflation in Pakistan is not demand-driven. Instead, there are supply constraints, which are very important to be addressed.
Another major issue of strategic significance is the whooping budget deficit and the seemingly easy way to meet it - external and domestic borrowing. It has to be realised that the economic strategies advised by the International Monitory Fund (IMF) does not correspond well with Pakistan's economic needs. The shift in strategy, needed to enhance the growth considerably and to check the deficits, remains missing. The economic managers need to have a vision regarding realistic growth targets, the type of resource allocations required to achieve those targets, and policy parameters, such as incentives for capital formulation and to encourage savings at national level. Unless links are established among all these inter-related factors, the economic improvement would remain an unfulfilled dream.
The unrealistic assessment of expenditure and projected income is another critical issue. An effort seems to have been made for a mere equation of income and expenditure in complete disregard to the situation on ground. Given the ever-questionable reliability of the official statistics, the risk of actual economic position being even worse is not out of question. Moreover, there are serious printing and computing errors in the budget documents which reflect lack of seriousness on the part of government and a plausible reason for prevailing deficit of trust on the government and its machinery.
Another notable point is that there is no way out of the present crisis without resource mobilisation and incentives for investment. The revenue collection target for Federal Board of Revenue (FBR) has been increased from Rs. 1580 to Rs. 1955 but the important questions are: whether FBR is in a position to realise this target and whether the bases which become a hindrance for collection of revenues have been removed. The original target for FBR for fiscal 2010-11 was over Rs. 1600 billion, which was reduced, and the revenue collected until May 2011 shows that unless there is a major jump in collection during June 2011, even the reduced target will not be met. This is a nerve-racking issue and there is no economic policy measure in the whole budget that focuses it. Unless the quantum of direct taxes is increased, this issue will not be addressed. Income Tax, Corporate Tax and Wealth Tax are important to address this issue.
Furthermore, uniform rate for indirect taxes, particularly of GST, on all commodities and all over the country is not a good strategy. This needs to be reconsidered with a view point of both equity and development. In developing as well as developed countries, there are two to three tiers/slabs for GST. In Pakistan, lower rates of GST for essential commodities should particularly be considered. It has been claimed in the budget that rate has been reduced by 1% but it actually is the reversal of 1% increase made in October last year. The finance minister says that some 0.7 million people, who must pay taxes, have been identified, and notices have been issued to 58,000 among them, believing that such measures will enhance revenues next year, which is far from being realistic. If people were to pay taxes because of 'notices', they would have been paying the same since long ago. It needs to be realised that the government is facing the deficit of trust and credibility. It has to develop stakes of the people in the government through good governance, transparency and by observing rule of law at the highest levels.
It is ironical to see the measures taken by the government in recent financial years as an easy way of making up the shortfall in revenues ie by heavily taxing the petroleum sector. During 2009-10, FBR collected Rs. 351 billion through taxes on petroleum products alone.
The breakdown was as follows:
-- Customs Duty: Rs 25 billion
-- Sales Tax at Import Stage: Rs 100 billion
-- Sales tax at domestic sale: Rs 114 billion
-- Petroleum Development levy: Rs 112 billion
CBR had already collected Rs. 163 billion as taxes on these products during the first six months of the fiscal year 2010-11. Any drop in these excessive tax collections is considered as a loss. On the other hand, the government continues to offer wrong 'facts' by telling the people that high prices of petroleum products are due to high prices in the international market.
Persistent deficit and its financing is yet another key area. The deficit is being met by external and domestic loans. The debt burden, therefore, has already assumed the alarming proportions. The projected deficit, which is feared to increase considerably during the course of current financial year, forestalls that the government will have to rely heavily on further borrowing. The huge sum of Rs. 786 billion consumed by interest repayments on public debt does not include repayments of the principal amount, funds for which will be financed through local and external borrowing. It is also surprising that no provision has been made for the repayment of IMF loan instalment, which is due in February next year.
As to the specific areas of budget, four important sectors namely agriculture, industry, energy and Public Sector Development Program need to be analysed deeply.
Agriculture has been, and remains the most important sector as far as the growth is concerned that has been completely ignored. Agriculture provides some 22% of GDP and 47% of employment to the total work force. Wheat exports alone brought in some $400 million during 2010-11. Pakistan's economy demands that the country should have a budget that can fund an agricultural led industrialisation. Such a policy will allow the indigenous industry to cater for its agricultural strengths as well as allowing it to convert its immense potential of natural resources into material that can drive an industrial revolution in the country. This in turn will create millions of jobs and increase national wealth.
One may recall the strategy announced in the first budget presented by the same government for FY 2008-09 to fund an agricultural-led industrialisation seems to have been abandoned without any reason. On the contrary the announced measures will raise the production cost. RGST was imposed on agricultural inputs in March this year. The levy of GST on agriculture inputs including fertilisers and pesticides have led to increase the production cost of farmers by Rs. 4000 per acre. GST on agricultural inputs will decrease their consumption by 10 to 15 percent, resulting in decrease in per acre yield of 10% at least.
Then there are practical questions of implementation. It is good to see that about Rs. 15 billion have been allocated for flood affected areas but real question is how this money will be spent. Similarly Rs. 18 billion allocated for Bhasha Dam which is more difficult to construct as compared to Kala Bagh Dam. Stakeholders of agriculture sector claim that never did they hear such a futile budget with regard to agriculture sector in the last at least two decades.
Besides agriculture, industrial sector holds a key position within the national economy and therefore should be the next major focus for a sustained and reasonable growth. The budget 2011-12 has both pros and cons for the industrial development and fast growth in the sector. The budget encourages enhanced equity financing, and to provide relief to new corporate industrial undertakings, established on or after 1st July 2011 with 100% equity financing, a tax credit equal to 100% of tax payable is proposed. The existing companies may also take benefit under this arrangement if investment in Balancing, Modernization and Replacement (BMR) is financed through their 100% equity on or after 1st July 2011. Sales Tax refund procedure automated Rs. 46 billion (as against Rs. 16 billion) disbursed. This improves liquidity of business and exporters. The rate of tax deductible on cash withdrawals from banks is proposed to be reduced to 0.2% from existing 0.3%, for bringing in improvement in the liquidity position of eligible taxpayers.
The budget, however, ignores incentives for sectors such as textile, surgical, leather, sports, carpet and developing sectors like marble, gems and jewellery, and furniture. Withdrawing subsidy on electricity would further increase the power cost up by 30 % unleashing a new wave of inflation and crippling industrial activities. In order to harmonise the existing tax credits available to individuals for investment in shares and for premium payable to insurance company, the maximum cumulative limit for both the investments is fixed at 15% of the taxable income with maximum upper limit for investment up-to 0.5 million. In this situation, investment and growth in the industry can hardly be expected.
Energy crisis, particularly the crisis of power sector, is yet another major issue from the point of view of development and growth as well as hardships faced by the domestic consumers. Energy sector has been badly paralysed by power crisis, which should have been resolved on priority basis to support small, medium and large business, industries and common man. Paucity of electricity hit hard the industrial, manufacturing and agriculture production in the last couple of years, which has slowed down the overall growth of economy and employment. In the growing crisis of energy, it was required from the budget to focus this sector as an exclusive area of attention but budget documents and announcements in this regard are total disappointment. A mere change in the mode of tariff adjustment and the naïve injunction that NEPRA will take care of it from now on, reflects the lack of seriousness of the policy makers about this extremely important sector. In fact, this regime has wasted a lot of time as far as measures to come out of the energy crisis are concerned: it has remained involved in search of short-term, costly solutions. The sector cannot come out of crisis unless the major issue of circular debt is tackled. The budget does not provide any scheme for the same. Similarly, there is hardly any tangible development regarding exploiting the potential of alternative sources of energy.
Apart from the power sector, there are also no incentives for the broader energy sector, particularly for oil and gas exploration and development. A major confusion, rather impediment, in this regard has been created with the passage of 18th Amendment, which needs to be addressed on urgent basis. Now oil and gas exploration from policy to licensing is a provincial subject, which is not the case in any other country except Pakistan. Along with the issues of consistency and continuity, there are problems with regard to the capacity of provincial governments, which have made the foreign investors reluctant from investing in exploration.
Similarly, there are questions regarding the whole scheme of Public Sector Development Program (PSDP). In the proposed Rs. 730 billion allocated for PSDP for the year 2011-12, the federal component is Rs. 300 billion, while the component of provinces is Rs. 420 billion. However, the key questions regarding PSDP are: how much of the PSDP will be used in the acquisition of tangible fixed assets; how much of it is used for replacement and how much for incremental capital formulation. As both finance ministry and Planning Commission-the two institutions responsible for joint preparation of PSDP-use different classifications and formats for the allocation, a comprehensive analysis is rendered very difficult. It is also worth mentioning that in case of any deficit in income/receipts, it is the PSDP that faces the major cuts in expenses, as current expenditure is not cut.
To analyse any budget, one also considers what measures it brings forward to reduce poverty and enhance employment. The budget is disappointing in this regard as well. How can poverty be reduced and employment be generated without focusing upon the critical sectors namely agriculture and industry? The relief measures announced in the shape of increase in salaries and pensions and Benazir Income Support Programme are, by and large, short term and politically motivated.
Political-economy has been a major determinant of Pakistan economic performance, particularly since 9/11 and US-led invasion of Afghanistan. A major issue while analysing Pakistani economy and budget is therefore linked with political economy, more specifically with the actual cost of 'war on terror' for Pakistan. Although reliability of the figures given by the government are generally contested as there has been no actual assessment of the losses inflicted upon the country's economy as a result of the participation in the War on Terror (WoT) since 2001, the figures of $67.9 billion given by the government are alarming. Unfortunately, however, there appear no signs of any new initiative to address the questions related to the issues of policy and approach towards WoT. It is quite obvious that unless delinked from WoT, Pakistani economy will hardly find a way out of the woods.
A related issue is concerned with the defence budget. Within the total outlay of Rs, 2767 billion (14.2% higher than the previous year), defence budget (Rs. 495 billion) is 17.9% of total expenditure. Defence budget is increased by 11.4% from the closing year. Going by this framework, it appears that the traditional pattern of broader budgetary contour has, by and large, been preserved vis-à-vis defence spending. Citing resource constraints, the government declined to accept the original request by the defence establishment for an 18% increase, (outlay of Rs. 524 billion), though that was closer to current year's spending. Defence spending in the last fiscal year was Rs. 586 billion, about 23% of the 2010-11 budget: by adding pension-related expenses of Rs. 71.9 billion, total spending would come to Rs. 658 billion or 25.6% of the total budget. Likewise, in the next year's additional allocation of Rs. 150 billion, almost half of it was billed under the Armed Forces Development Program and Rs. 73.2 billion paid from the civilian account as military pensions, the net allocation stands at Rs. 718 billion, that accounts for around 26% of the total budget.
However, these funding practices of defence spending through other heads are a common occurrence. Many countries, including India and China, plan their funding of defence spending in a similar format. The main distribution of defence budget is: 41% (Rs. 206.4 billion) for human resource related expenses, 26% (Rs. 128.2 billion) for operating expenses, 23% (Rs. 117.5 billion) for physical assets, and 8.6% (Rs. 42.6 billion) for civil works. The share of three services is rationalised based on the strength of each service and the requirement for the weapons and equipment. At current rates, defence budget is only 2.35% of Pakistan's GDP, which is not much considering the extraordinary security challenges faced by the country as well as defence spending of other countries of the region.
Conclusion
The above review of the budget reveals that this important document is stained with three major deficits ie the deficits of vision, strategy and credibility. Along with deficits there are surpluses as well, which include surplus of unrealistic and unattainable receipts; underestimated deficits in macro-economic indicators as well as in development; and surpluses of false promises. The budget 2011-12 does not seem responding to the extraordinary challenges faced by Pakistani economy. It seems, at best, an exercise aimed at creating a mere equation of income and expenditure. There are hardly any tangible incentives for growth and investment. Critical sectors have been ignored, and budgetary targets seem too optimistic to be achieved.
(The analysis prepared by a Task Force of the Institute of Policy Studies, Islamabad, comprising eminent economists, experts, practitioners and intellectuals.)