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Anomalies in the federal budget

ARTICLE: The Federal Budget for 2020-21 is unfortunately not as very well-crafted or well-presented as some previous...

June 30, 2020

ARTICLE: The Federal Budget for 2020-21 is unfortunately not as very well-crafted or well-presented as some previous budgets. The IMF has effectively put the government in a strait jacket by releasing in advance the budgetary projections for 2020-21 in April as part of the report prepared for the IMF Executive Board to justify the access of Pakistan to the Rapid Financing Facility in view of the negative impact caused by Covid-19.

The extent to which the actual budgetary magnitudes correspond to the projections in this earlier IMF report is extraordinary. Revenues were projected at the Federal level at Rs 6646 billion in this report for 2019-20. The target in the Federal Budget is Rs 6572 billion, indicating a divergence of only 1 percent. Similarly, the IMF projection for current expenditure was Rs 6277 billion while the budget estimate is Rs 6345 billion, representing a difference of also only 1 percent.

The pressure to virtually match the earlier IMF projections has put the Ministry of Finance under enormous pressure. Consequently, a number of estimates have been made which diverge substantially from the underlying reality. Many of these anomalies are identified below.

First, there is the questionable basis of FBR Revenue projections. The two principal tax bases are large-scale manufacturing and imports. The Annual Plan for 2020-21 approved by the National Economic Council projects a negative growth rate of 2.5 percent in large-scale manufacturing while imports are expected to fall by as much as 17 percent. Inflation is also expected to moderate to 5 to 7 percent. With these developments, a target growth rate of 27 percent is wildly ambitious, especially with a 'tax-free budget'. However, even if taxation proposals are introduced later on they will not yield substantially more revenues in a very slow economy. On the contrary, they could lead to further contraction of the tax bases and slow down the economy further. Only a few days ago, the IMF reduced its growth rate projection from 2 percent to 1 percent in 2020-21. The inevitable conclusion is that tax revenues are unlikely to exceed Rs 4300 billion in 2020-21, implying a shortfall of over Rs 650 billion.

Second, the big revenue growth item anticipated next year is in the petroleum levy of 73 percent. This is attributable to the doubling of the levy on the two major petroleum products - motor spirit and HSD oil. However, part of this benefit has already accrued this year. However, the volume of sales continues to decline. The massive increase in prices of petroleum products last weekend will reduce demand further by over 10 percent. Therefore, the revenue may not exceed Rs 410 billion next year, implying thereby a shortfall of Rs 50 billion.

Third, over-emphasis continues to be placed on the profits of the SBP as by far the principal source of non-tax revenue. The anomaly is that higher profits of the SBP reduce the primary deficit but leave the budget deficit unchanged. The focus in the IMF programmes of previous years used to be on the size of the budget deficit as this is what determines the rate of evolution of public debt. This is the first time that emphasis has shifted towards containment of the primary deficit.

The expectation is that SBP profits could fall by 21 percent in 2020-21. As interest rates have come down sharply in line with the fall in the policy rate from 13.25 percent to 7 percent, these profits will come down eventually to even lower levels. Also, the recent fall in the rupee has implied capital losses on the holdings by SBP of other central bank deposits and SWAP funds. If the rupee continues to fall sharply in 2020-21 as foreign exchange reserves have fallen below $10 billion then the big target of profits of Rs 620 billion will become more and more elusive.

Fourth, there are other sources of non-tax revenues which are unlikely to achieve the level projected in 2020-21. Mark-up payments are over Rs 87 billion less than the budgeted level in 2019-20. This is clearly a reflection of the worsening financial condition of Public State Enterprises (PSEs) and a big reduction thereby in their ability to service their debt obligations with the Federal Government. Despite this, the expectation in the 2020-21 Budget is of enhanced payment of Rs 56 billion. Further, dividend of Rs 61 billion are expected from these enterprises. The biggest contributor is OGDC, but its profitability has been badly affected by the big fall in oil price. As such, there is likely to be a big shortfall also in the inflow of dividends.

Fifth, there is the problem on the expenditure side of a projected decline in interest payment on external debt. It is expected to fall in rupee terms by 6 percent in 2020-21. Even with some debt relief, the continuing depreciation of the rupee should imply higher payment. The understatement is probably of up to Rs 40 billion.

Sixth, there is a major problem in grants of the magnitude of payment against contingent liabilities in 2020-21. The quantum of debt of SOEs guaranteed by the Federal Government has shown an extraordinary jump of 49 percent to almost Rs 1.9 trillion in 2019-20. Yet the contingency provision has been increased by only 7 percent in the next years' budget. It could be as much as Rs 80 billion higher.

Seventh, subsidies to the power sector are expected to fall sharply by Rs 111 billion in 2020-21. The Budget Speech ought to have provided an explanation as to why and how this big saving will be achieved. The probability of reducing the inter-disco tariff differential looks low given the state of the sector unless a big escalation of tariffs will be resorted to in coming months. This will contribute to further deepening the recession in the economy.

Eighth and last, there is the optimistic expectation that the four Provincial Governments combined will be able to generate a cash surplus of Rs 242 billion, which will reduce the consolidated budget deficit by over 0.5 percent of the GDP in 2020-21. However, even after assuming the full 20 percent increase in Federal transfers only one Province, Punjab has shown a cash surplus. Khyber-Pakhtunkhwa has a balanced budget while both Sindh and Balochistan have shown deficits. Clearly, the target for a cash surplus of Rs 242 billion will not be met.

Overall, the pressure of IMF to show high growth in revenues and strongly contain expenditure, leading thereby to a big reduction in the size of the primary deficit has led to biased and unrealistic estimates in the Budget of 2020-21. Revenues are substantially overstated while expenditures next year are underreported.

The two years of the present government have witnessed big slippages in attainment of the budget deficit target. It was exceeded by almost 2 percent of the GDP in 2018-19 and there is the likelihood by over 2 percent of the GDP this year. Based on the above anomalies, there is the risk that this divergence could be repeated again in 2020-21, with the target deficit of 7 percent of the GDP rising to almost 9 percent of the GDP once again.

(The author is Professor Emeritus at BNU and former Federal Minister)

Copyright Business Recorder, 2020