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The information on fiscal operations from July to December 2022 of the federal and the provincial governments has recently been released by the federal ministry of finance. The consolidated budget deficit of these five governments has been estimated at 2% of the GDP, with a primary surplus of 1.1% of the GDP.

The expectation at the start of the current fiscal year was that the combined budget deficit will be brought down by 3% of the GDP from 7.9% of the GDP in 2021-22. In absolute terms, this will require a reduction in the size of the deficit by as much as 28%. This quantum of reduction has never been achieved before. However, the budgetary framework in the IMF program is based on the strong exercise of contractionary fiscal policy to help in the containment of aggregate demand in the economy and thereby restrict the size of the current account deficit.

The emergence of problems on the budgetary front is highlighted by the outcome in the first half of 2022-23 whereby the budget deficit stands at 2% of the GDP. This is the same as the deficit in the first six months of 2021-22. Therefore, there will have to be massive reduction in the deficit from January to June 2023, compared to last year, by 3% of the GDP. This is extremely unlikely.

There is, however, one positive development. A large primary surplus has been generated of 1.1% of the GDP as compared to 0.1% of the GDP in the first half of 2021-22. This is attributable to the rise in cost of debt servicing by almost 1% of the GDP. This improvement is reassuring because the IMF is likely to focus more on the size of the primary deficit.

A comparison of the outcome with that in 2021-22 reveals that the tax-to-GDP ratio has fallen by almost 0.4% of the GDP, while total expenditure is lower by 0.4% of the GDP, leading thereby to the same size of the overall budget deficit. Non-tax revenues have remained at close to 1% of the GDP.

There was a large set of taxation proposals in the federal budget of 2022-23, with the anticipated yield of almost Rs 600 billion. Yet the tax-to-GDP ratio has fallen. An analysis of the individual federal taxes performance reveals that the income tax has performed exceptionally well with an unprecedented growth rate of 50%.

However, the three indirect taxes combined have shown no growth in revenues. Consequently, the overall growth rate in FBR revenues is 17%, whereas the target growth rate for the year is 22%. Nevertheless, the federal tax system has become significantly more progressive.

The poor performance of the import sales tax and customs duty is attributable to the severe contraction in imports, especially by physical and administrative controls. Between July and December 2022, the rupee value of imports has increased by only 1%. Similarly, domestic sales tax revenues have been constrained by a fall in output of the large-scale manufacturing sector between July and November of 3.6%. Excise duty revenues have also been restricted by a fall in the production of cigarettes by over 22%.

Turning to non-tax revenues, the federal budget had set target of a big increase of 68% in 2022-23. Instead, the growth rate achieved is 28%. The anticipation was that with the increase in petroleum levy to Rs 50 per litre, revenues from this source would jump up from Rs 128 billion in 2021-22 to as much as Rs 855 billion in 2022-23. However, the increase is Rs 120 billion in the first six months, which is only 16% of the required annual increase.

Here again, the tax base has shrunk due partly to the rise in retail prices of petroleum products and because of restricted traffic volumes during the floods. The consumption of motor spirit and HSD oil has fallen by 15% and 24%, respectively, in the first six months. The likelihood is of a major shortfall in revenues from the petroleum levy in 2022-23.

One of the primary means proposed for a quantitative reduction in the size of the budget deficit is a severe containment in the growth rate of current expenditure to only 3% in 2022-23. But the opposite has happened. The growth rate in current expenditure in the first six months has been as high as 16%. This has forced a big cut in development spending, which is down by as much as 40%.

The primary reason for the unanticipated growth is the much higher cost of debt servicing. It has already increased by over Rs 1 trillion, with a growth rate of 73%. Clearly, the budget makers had not anticipated the full budgetary impact of the policy of increasing interest rates by the SBP to stabilize the economy.

The pressure on the federal budget will continue with the recent increase to 17% of the policy rate and the likelihood that it will increase further in coming months. It will not be surprising if the cost of debt servicing rises to above Rs 5 trillion by the end of 2022-23.

Fortunately, there has been some economy in other current expenditure which has been reduced by 4% in relation to last year’s level. Both subsidies and grants have seen a reduction in absolute magnitudes. This is perhaps surprising in light of the relief and rehabilitation expenditures due to the floods. The answer lies in a reported large statistical discrepancy of Rs 315 billion arising from the overstatement of expenditure. Last year, during the first six months, there was an understatement in expenditure of Rs 81 billion. The Ministry of Finance apparently has gone back to finding ingenious ways of understating the budget deficit.

The provincial governments have shown a combined cash surplus of only Rs 101 billion, whereas the annual target for 2022-23 is substantially higher at Rs 750 billion. Both current and development expenditures are up by 24%. The rise in current expenditure can be attributed partly to flood – related spending. However, more expenditure restraint will be required in coming months to generate a much larger cash surplus.

The IMF staff mission for the ninth review has focused strongly on the budget position. Fortunately, a primary surplus of 1% of the GDP has been achieved in the first six months. There has apparently been agreement with the government for actions to sustain a primary surplus till the end of 2022-23. Additional taxation proposals of Rs 170 billion will be introduced shortly. The subsidies to the energy sector will be reduced by big escalation in power and gas tariffs. The IMF has probably accepted the need for targeting a larger budget deficit of up to Rs 500 billion due to the extra flood-related expenditures.

Overall, there are many risk factors related to the budgetary outcome in 2022-23. This includes contraction in the volume of both the import and domestic bases, reduction in growth in income tax revenues due to a big decline in corporate profitability and continued lower sales of petroleum products limiting the revenues from the petroleum levy.

We hope that efforts will be made to coming close to limiting the consolidated budget deficit to 6% of the GDP in 2022-23. This will still represent a significant effort in achieving a reduction in the deficit by almost 2% of the GDP in relation to last year’s level. It will also be the lowest deficit as a percentage of the GDP since 2017-18.

Copyright Business Recorder, 2023

Dr Hafiz A Pasha

The writer is Professor Emeritus at BNU and former Federal Minister


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