The Federal budget for 2019-20 will be presented tomorrow in the Parliament. This budget has considerable significance. First, it will present the expected budgetary outcome for the on-going financial year, 2018-19. This will enable an assessment of the quality of fiscal management displayed by the PTI government in its first year in office. Second, the budget for 2019-20 is expected to accomplish the fulfillment of prior conditions agreed with the IMF on the fiscal front as part of a new Programme. Third, there should be some indication in the Budget Speech of the medium term budgetary strategy as per past practice that will be implemented by the present Government. In effect, the budgetary targets agreed with the IMF will need to be made more explicit.
The objective of this article is to highlight first the likely budgetary outcome this year. This will be followed by identification of the prior conditions agreed with the IMF to be fulfilled in the forthcoming budget. Next, the expenditure priorities and levels for next year which have already been revealed will be highlighted. Finally, some projections are made of the key Federal budgetary magnitudes for 2019-20.
Budgetary outcome in 2018-19 There has been a spate of budgetary announcements in 2018-19. The budget was presented initially by the PML (N) Government just prior to its exit. It focused more on tax concessions and a big increase in development spending in an effort to garner more votes in the forthcoming elections. Consequently, there was an unprecedented tripling of the exemption limit in personal income tax from Rs 400,000 to Rs 1,200,000. The PSDP was proposed to be increased by 21 percent to Rs 800 billion, including a number of Special Programmes.
The newly-installed PTI presented a Supplementary Budget for 2018-19 in September 2018. The primary emphasis was on achieving a modicum of fiscal stabilization. More revenues were to be generated by FBR primarily through improvements in tax administration. The enhancement in the exemption limit was effectively retained with the exception of small lump taxes below Rs 1,200,000 and the maximum tax rate was raised from 15 percent to 29 percent. The big cut was in the size of the Federal PSDP which was reduced by Rs 225 billion.
Four months later a Mini Budget was also announced. In the intervening period the economy had visibly slowed down and a reverse gear was applied. A number of tax reliefs were given to the corporate sector, exporters, banks and the stock market. There was also a de facto increase of Rs 100 billion in the size of the Federal PSDP to Rs 675 billion. Overall, inclusive of Provincial cash surplus of almost 1 percent of the GDP the consolidated fiscal deficit was expected to be contained to 5.1 percent of the GDP as compared to the substantially higher level of 6.6 percent of the GDP in 2017-18.
As the year has progressed, a number of negative developments have become visible. First, as opposed to the target growth in FBR revenues of over 14 percent, the actual growth will be very low single-digit, depending on the revenues mopped up through the on-going asset declaration scheme. Second, non-tax revenues have actually demonstrated negative growth in the first nine months.
The other worrying development has been the upsurge in current expenditure of almost 20 percent in the first three quarters. The cost of debt servicing has jumped by as much as 24 percent, due primarily to the hike in interest rates announced by the SBP since July 2018. Simultaneously, defense expenditure has, inclusive of pensions, risen by 23 percent. The only visible restraint has been shown by the Provincial Governments in development spending, especially by the Government of Punjab. The cut by this Government is likely to be over 65 percent in relation to the level of ADP spending achieved in 2017-18.
Given the above developments, it is clear that the consolidated budget deficit in 2018-19 will be substantially larger than the level targeted for. A likely estimate is that it will approach Rs 2900 billion, equivalent to 7.6 percent of the GDP, as compared to the budgeted level of under Rs 2000 billion or 5.1 percent of the GDP. The spillover in the size of the deficit of over Rs 900 billion is the largest ever. This reflects somewhat poorly on the quality of management of the budgetary process by the Ministry of Finance. Already, according to the date on fiscal operations, the deficit had reached 5 percent of the GDP in the first nine months. The last quarter usually has the largest quarterly deficit. For example, it was 2.3 percent of the GDP in the fourth quarter of 2017-18.
The reader needs to be forewarned that the MOF has adopted an unfortunate practice in presenting biased information in the budget documents that are made available to the National Assembly at the time of the Budget Speech. These documents contain the so-called 'revised estimates'. No explicit indication is given of the expected size of the consolidated deficit for the year about to end.
Therefore, it becomes necessary to wade through the large number of budgetary numbers to arrive at an estimate of the level of the deficit. The revised estimates generally tend to underestimate substantially the deficit. For example, in 2017-18 the revised estimates implied that the budget deficit was 5.3 percent of the GDP, which turned out to be 6.6 percent of the GDP. Similarly, the revised estimates yielded a deficit of 4.2 percent of the GDP in 2016-17 which was later revealed to be much higher at 5.6 percent of the GDP. As a thumb rule, the revised estimates tend to understate the 'true' consolidated budget deficit for a particular year by at least 1 percent of the GDP. This needs to be noted, in particular, by the Standing Finance Committee of the National Assembly.
IMF programmeme's prior conditions The IMF staff press statement issued at the end of the negotiations in Islamabad does highlight some prior conditions which have implications on the forthcoming budget. First, the 'primary' deficit is expected to be reduced to 0.6 percent of the GDP in 2019-20. Therefore, the gap between total national revenues and non-interest expenditure has to be narrowed considerably. It is estimated at almost 2.4 percent of the GDP in 2018-19. As such, there will have to be an extremely big reduction of 1.8 percent of the GDP in only one year. This will tantamount to a massive 'front loading' of the process of fiscal stabilization in the country.
Apparently, this is to be achieved primarily by a quantum jump in FBR tax revenues, which are likely to show a big shortfall this year and with some difficulty exceed Rs 4000 billion. They are expected to rise to Rs 5550 billion in 2019-20, implying an extremely high growth rate of almost 39 percent. Consequently, the overall tax-to-GDP ratio is projected to rise from 12 percent of the GDP to 14.6 percent of the GDP in one year. This is completely unprecedented.
The IMF expects the additional tax revenues to be generated by measures to 'eliminate exemptions, curtail special treatments and improve tax administration'. This is expected to lead to 'a more equal and transparent distribution of the tax burden'. The ultimate litmus test of the Federal budget for 2019-20 will be how the much higher FBR tax revenues are to be mobilized. Will the measures proposed in the Finance Bill be adequate to achieve the extremely difficult target and will progressivity of the tax burden be ensured? Raising additional Rs 1100 billion, beyond the normal growth in revenues of Rs 450 billion, will inevitably place the burden also on the lower income groups and possibly lead to a measure of public protest.
There are implications of the other prior conditions which also need to be highlighted. First, electricity and gas tariffs have to be enhanced by 20 to 25 percent. The Government has clearly indicated that it will retain the electricity tariff at Rs 2 per kwh for domestic consumption up to 300 kwh per month. This will necessitate an additional tariff differential subsidy in the budget of over Rs 80 billion. Overall, estimates are that the additional tax burden plus the higher cost of utilities minus the increase in subsidies will place an additional burden on the typical family of Rs 41000 in 2019-20.
Second, interest rates are to be raised sharply in an effort apparently to reduce the investment-savings gap, which ex post is equal to the current account deficit in the balance of payments. But this has very adverse budgetary implications. Already, the almost 600 basis points jump in the SBP policy rate in 2018-19 has led to a 33 percent or more jump in the interest cost of debt servicing. There is the prospect of another jump in the interest cost in the budget of 2019-20 by almost Rs 800 billion. This will put severe pressure on the overall budget deficit which could approach 6.8 percent of the GDP next year, due particularly to the extraordinary large increase in debt servicing even in the presence of a record target increase in tax revenues.
The IMF has actually revealed some concern also for the rise in the incidence of poverty in the process of stabilization for which thanks are due. The additional taxation is to be accompanied by 'prudent spending growth aimed at preserving essential development spending, scaling up the BISP and improving targeted subsidies'.
Announcements Prior to the presentation of the budget some announcements have been made which have significant budgetary implications. Perhaps the most important announcement has been by the leadership of the Armed Forces that no additional budget will be asked for in 2019-20. This voluntary gesture must be greatly appreciated and comes even in the presence of greater border tensions and somewhat more acts of terrorism.
Historically, over the five year period, 2012-13 to 2017-18, defense expenditure had grown somewhat rapidly, as anti-terrorism operations were launched like the Zarb-e-Azb and more recently, Radd ul Fasaad. During this period, the expenditure on defense services almost doubled while on military pensions the cost nearly tripled. .The year, 2018-19, has already witnessed an increase in defense spending of almost 23 percent in the first nine months as compared to a budgeted growth of less than 8 percent. Clearly, the Army has realized the need for economy in expenditure in 2019-20 at a time when enormous pressure is being put on Pakistan to stabilize the budgetary position. The lack of growth in defense spending will imply a saving in expenditure of over Rs 150 billion. Hopefully, civilian institutions will also replicate the wonderful gesture by the Armed Forces.
The Annual Plan was presented recently to the National Economic Council (NEC), chaired by the Prime Minister. The national PSDP for 2019-20 was also placed before the NEC. The size of the Federal PSDP is proposed at Rs 925 billion, including Rs 250 billion for public-private partnerships. The combined size of the Provincial ADPs has been set at Rs 912 billion. The overall development spending targeted for in 2019-20 is Rs 1837 billion, equivalent to 4.2 percent of the projected GDP. This will represent a big jump from the estimated 3 percent of the GDP in 2018-19. This may not be feasible given the sharp deficit reduction target. The forthcoming Budget Speech will highlight the proposed size of development spending in 2019-20.
The greater commitment to social protection is demonstrated by the proposed increase in the size of the BISP from Rs 120 billion to Rs 180 billion next year. However, given the slowdown in the economy and rising inflation more will be needed to tackle the problem of rising poverty.
Table 1.
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Federal Budgetary Projections for2018-19
and 2019-20 - (% of GDP)
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2018-19 2019-20
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Total Revenues 12.6 15.2
Tax Revenues 11.0 13.4
Non-Tax Revenues 1.6 1.8
Transfer to Provinces -6.0 -7.4
Total Expenditure 14.6 15.6
Current Expenditure 12.3 12.9
Debt Servicing 5.2 6.2
Defense 3.2 2.9
Others 3.9 3.8
Development Expenditure 2.3 2.7
PSDP 1.7 2.1
Others 0.6 0.6
Provincial Cash Surplus 0.4 1.0
Budget Deficit -7.6 -6.8
Primary Deficit -2.4 -0.6
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Budget projections for 2019-20 These are derived on the basis of the Annual Plan's projections that the GDP growth rate will be 4 percent while the rate of inflation will rise to about 8.5 percent in 2019-20. Based on the above, a first set of Federal budgetary projections is presented in Table 1, along with the expected budgetary outcome in 2018-19. The most uncertain and risky projection on which the next year's budget will fail or succeed is the increase in the tax-to-GDP ratio by 2.4 percentage points in one year. The last time such an increase was achieved was in four years from 2012-13 to 2016-17.
One the expenditure side, debt servicing is projected to increase by 1 percent of the GDP. The voluntary restraint in expenditure shown by the Armed forces will lead to a fall in defense spending of 0.3 percent of the GDP. Given the proposed big jump in the size of the Federal PSDP it will increase by 0.4 percent of the GDP.
There is likely to be a jump in transfers to the provincial governments of 1.4 percent of the GDP, as a result of the targeted big increase in revenues from the divisible pool of taxes. Therefore, they should be able to generate a cash surplus of at least 1 percent of GDP. The consolidated budget deficit is expected to decline to 6.8 percent of the GDP in 2019-20 from 7.6 percent of the GDP in 2018-19. This implies that the primary deficit may fall from 2.4 percent of the GDP in 2018-19 to 0.6 percent of the GDP in 2019-20. Consequently, the target agreed with the IMF could be achieved.
The remaining fundamental question is what happens if there is a significant shortfall in attaining the ambitious FBR revenue target? The answer depends on the quarterly performance criteria for Programme Monitoring agreed with the IMF. In the last Programme from 2013 to 2016, there were five performance criteria, including the budget deficit. The floor on FBR revenues was included only as an indicative target.
The problem becomes more serious if both FBR revenues and the budget deficit are included as performance criteria. In this case FBR will have to find ways to recover any revenue shortfall. The tendency then will be to find relatively easy and feasible solutions like an enhancement in the standard rate of GST to above 17 percent and/or an increase in import tariffs, especially the lowest slab of 3 percent. Both these solutions are not only inflationary in character but will add disproportionately to the tax burden of the lowest income groups.
Overall, the Budget for 2019-20 will add to risk and uncertainty in the economy. There are serious doubts about the economic, administrative and political feasibility of achieving the targets related to the big growth in FBR revenues and the steep reduction in the primary deficit. We look forward to hearing tomorrow the strategy that the PTI Government proposes to adopt to meet the many challenges. We wish the government success in its efforts.
(The writer is Professor Emeritus at BNU and former Federal Minister)
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