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IMF’s target of primary surplus has been met comfortably, indicating that fiscal consolidation is continuing at full speed. All provinces have shown surpluses. Total fiscal revenue (as % of GDP) touched a two-decade high – as non-tax sources became major contributors to . Unfortunately, the expenditure side looks no different. Total fiscal expenditure (as % of GDP) came in at 20-year high as well – where, no surprises, debt servicing remained the biggest expenditure head.

Expenditure net of debt servicing grew by 18.8 percent over same period last year, largely in line with tax revenue growth at 18.4 percent. Barring one-offs (high debt servicing and high non-tax revenues), fiscal numbers are speeding ahead at 18-19 percent, a few percentage points higher than nominal GDP growth.

Debt servicing is the bone of contention as it not only dwarf’s other expenditure heads in comparison but is also mounting owing to high interest rates.  Fortunately, achieving primary fiscal surplus (0.7 percent of GDP in 1HFY20) means that debt accumulation is slowing down. Once the discount rate begins to climb down, consolidated fiscal deficit will decline as well. However, the devil is in the detail - higher growth in non-tax revenues - (read: higher central bank profits) is partly thanks to higher interest rates.

Total fiscal deficit in 1HFY20 stood at Rs 995 billion, which at 2.3 percent of GDP is at a four-year low. Fiscal deficit in 2QFY20 stood at 1.6 percent, whereas it was 0.7 percent of GDP in 1QFY20.  The slippage may increase in third and fourth quarter.

Federal tax revenues grew by 18.8 percent to Rs 2.25 trillion while provincial tax revenues increased by 14.2 percent to Rs 214 billion. Slower growth rate in provincial number is partly explained by lack of incentive for provinces to enhance their collection.

Provinces invariably receive about three-fifth of FBR revenues while debt and defense liabilities remain federal subjects. On the other hand, this means that efforts at federal level to maximize FBR revenues - and contain deficit - become diluted as major share is taken by provinces.

On the flipside, non-tax and tax revenues (other than FBR collection) are beneficial for federal government. These revenues are not shared with provinces and all proceeds can go toward curbing consolidated deficit. Federal government was lucky to receive higher non-tax revenues in 1HFY20, which grew over three times. Note that one-off pending telco licenses stand at Rs 112 billion in 1HFY20.

The second element is of SBP profits – central bank passed Rs 427 billion as surplus profits to government, which is 6.7 times last year. In case of other tax revenues (those not shared with provinces), government collected Rs 157 billion in 1HFY20 – up by 58 percent.

The implication of non-shared revenues is profound in terms of deficit reduction. Debt servicing cost in terms of net federal fiscal revenue was 95 percent last year (1HFY19). This year first half, it was reduced to 78 percent. This is despite the fact that debt servicing increased by 46 percent to Rs1.28 trillion in 1HFY20. Had the non-FBR federal revenues growth been in line with last year, the government would have had to acquire more debt to pay existing debt. Forget about any other expense.

The lopsided federal fiscal arrangement created in the aftermath of 18th amendment and 7th NFC award has created perverse incentives for greater focus on non-FBR federal revenues. That is why in the recent IMF review, MoF is trying to get higher revenues from petroleum levy (PL). The reason for showing primary surplus in 1HFY20 is due to over 3 times spike in non-tax revenues.

But things will only remain cozy for so long; that is, until higher surplus profits from SBP continue to rake in. Telcos dues are still pending but face litigation. That is why privatization proceeds (not from direct government holdings as these could be treated as non-tax revenues) are imperative for attaining primary fiscal deficit target for full year.

In other words, about 58 percent of FBR revenues increase will not go towards efforts to reduce consolidated fiscal deficit (unless provinces show the same as surplus). On the flipside, 100 percent of PL, SBP profits, dividends, privatization, PTA profits contribute to deficit reduction.

The key is to find sustainable ways of increasing non-FBR revenues for broader fiscal consolidation in the medium term. At this point debt servicing is too high. Once the interest rates tame, fiscal consolidation would be more visible. The fundamental advantage of tight monetary policy on the fiscal side is that government is on its toes to reduce non-debt expenditure and is focused on revenues. Without higher rates, such sense of urgency would not have been possible.

Fiscal Position (Rs Bn) 1HFY20 1HFY19 YoY 2QFY20 1QFY20 QoQ
Budget Deficit (995) (1,030) (709) (286)
as % of GDP 2.30% 2.70% 1.60% 0.70%
Primary Balance 286 (153) 1 286
as % of GDP 0.70% -0.30% 0.10% 0.60%
Tax Revenue 2,465 2,083 18% 1,322 1,143 16%
Non-Tax Revenue 767 245 213% 421 346 22%
Other current Expenditure 1,910 1,627 17% 1,142 767 49%
Debt Servicing 1,281 877 46% 710 572 24%
Defence Spending 530 480 10% 287 243 18%
Development Expenditure 473 369 28% 326 147 122%
Source: Finance Ministry

Back to the big picture. FBR revenues are up by 17 percent to Rs2.1 trillion; but have fallen short even off the revised target. At best, government can fetch Rs 4.7 - 4.8 trillion in the full year. However, given the economic slowdown and import compression, performance in the first half is not dismal. Direct taxes are up by 17 percent to Rs 784 billion in 1HFY20 – but appear to be tapering off as growth in first quarter was 21 percent. Sales tax collection increased by 24 percent to Rs 859 billion – which is much better than first quarter growth of 13 percent.

Overall fiscal expenditure increased by 26 percent to Rs 4.23 trillion. Ex-debt servicing, expenditure growth falls to 19 percent – which is still too high. Current expenditure increased by 25 percent to Rs 3.36 billion whereas defense expenditure increased by 10 percent to Rs 530 billion. Development expenditure picked pace too, growing by 28 percent to come in at Rs 473 billon. However, development expenditure is less than defense (barring pension of retired officers and rankers). During 1HFY02-18, average development expenditure was 0.94 times the spending on defense, which has increased to average of 1.21 in 1HFY19 -20.

Federal fiscal deficit stood at Rs1,286 billion, up by 1 percent from same period last year. Including provincial surpluses, overall fiscal deficit stood at 995 billion; lower by 3 percent year on year. As a percentage of GDP, deficit in 1HFY20 reduced to 2.3 percent as compared to 2.7 percent during the same period last year. Primary balance has improved from a deficit of 0.3 percent to a surplus of 0.7 percent.