There is almost universal recognition that budget mismanagement is the mother of all economic ills in the country. It is responsible for excessive money creation and inflation, lowering the national saving rate, crowding out the private sector in the matter of credit availability, throwing the government in an internal and external debt trap, and adding pressure on the exchange rate and the balance of payment.
Proper budget management should be the top priority of the government and an important aspect of it is the reformation of the process of budget making and its monitoring. At present, the major flaw in the federal budget making process is that it is a show run exclusively by the Ministry of Finance (MoF) with no checks and balances and no accountability mechanism in place. The Planning Commission of Pakistan (PCP), the Federal Board of Revenue (FBR), the Economic Affairs Division (EAD) and the State Bank of Pakistan (SBP) are there to assist but not to contribute as equal partners under the present situation. In one way or the other, all of them have become subordinate departments of the MoF.
The budget estimates for a fiscal year are prepared exclusively by the Ministry of Finance (MoF); those are hurriedly approved by the cabinet in a brief session and presented to the National Assembly (NA) along with a budget speech by the finance minister. The NA undertakes no verification of the authenticity of statistical and other information.
Once the budget is passed by the NA, its implementation by the MoF takes a different route. Large-scale deviations begin to take place from the very beginning and continue throughout the year without any accountability and without the knowledge and approval of the NA. All those deviations and violations are then included in the budget documents for the next year for implicit post facto information and approval of the NA.
Another major flaw is that the public sector enterprises (PSEs) are excluded from the budget although they are run like government departments. These corporations end up with huge losses each year that are covered by government guaranteed bank loans. Their deficit is in reality a part of the budget for all practical purposes but is kept out of the budget estimates. The initial logic for their separation from the budget was that those were commercial organisations and were to be run in the same way as private sector corporations. But in reality those are being managed as attached departments of ministries incurring losses and should be included in the budget.
The provincial budget-making process is equally flawed. Provinces make very little tax effort and depend on their share in the pool of federal taxes under the NFC Award. The provinces have no mechanism either to cut expenditure or raise resources on their own if there is a shortfall in their revenue receipts from the federal government, and they end up with unpaid bills to the private sector or build-up of debtor balances with the banking system.
What happens to the budget subsequent to its approval is illustrated briefly with reference to the consolidated budget statistics for FY11. The actual outcome of the consolidated budget for FY11 shows that the budget outcome had no resemblance with the budget estimates of revenue, expenditure and financing of the deficit. All the deviations were one directional and could be anticipated because of unrealistic assumptions used in the original estimates to make the budget look good.
Revenue was originally overestimated and expenditure was understated. There was a shortfall of 25 percent in domestic revenue compared with the budget estimates and of 42 percent in external financing. At the same time, there was overshooting of current expenditure by 15 percent and reduction of 30 percent in development expenditure resulting in an overall expenditure that was 6 percent higher than the budget estimates. These deviations in revenue and expenditure increased the overall budget deficit by 74 percent. The additional gap was filled by bank borrowing which was 369 percent higher than the budget estimates. Its consequences for monetary policy were that 63 percent of money supply (M2) was generated by the government sector, making the monetary policy subservient to fiscal needs. The same will be the outcome of an analysis for any other recent budget year.
As regard PSEs, they incurred huge losses during the year that were ultimately taken over by the government by issuing special treasury bills of close to Rs 400 billion. It is quite clear that the budget presented to the legislature and approved in the beginning of the FY is usually for window-dressing purposes. The actual budget moves on a different path from the very beginning of the fiscal year.
If the government is to take seriously its deteriorating budgetary situation, not only does it need to restructure the taxation system to broaden its base, document the economy and improve tax collection, it also needs to totally revise the budget-making process to impart some integrity to fiscal statistics, introduce some checks and balances on the MoF, and put in place a monitoring and accountability mechanism to ensure that budget estimates are worked out responsibly and the actual outcome is not vastly different from the original estimates.
The following changes are recommended in the preparation, approval, implementation, monitoring and surveillance of the budgetary developments to produce better fiscal results:
---- Preparation of the budget estimates should be a multi-agency task and those agencies should be working as partners on equal footing and not as subordinate agencies of the MoF. The SBP, the FBR, the PCP and the EAD should be freed from the control of the MoF. They should provide estimates of their respective areas to the MoF objectively and professionally for the preparation of the budget estimates without the MOF having a veto power over their estimates.
The SBP should provide estimates of the scope of government borrowing from the banking system that is consistent with the agreed targets of growth rate, inflation and balance of payments, the FBR should provide best estimates of revenue collection from the existing tax system with every improvement in tax administration that it can effect and the PCP and the EAD should give their best estimates of external budgetary support. Based on the expenditure levels determined by the MoF and the PCP, the residual budget gap should be worked out that to be filled through additional domestic real revenue mobilisation effort and additional budgetary support from abroad. The main focus of the MoF should be additional taxation and additional external resource mobilisation to fill the gap. To the extent additional taxation and additional foreign budgetary support cannot be mobilised to fill the budget gap, expenditure needs to be reduced rather than indulge in inflationary financing of the residual gap. This is the only way to put the budget under certain discipline.
---- The present practice of overestimating revenue from the existing system, understating expenditure and making minimum tax effort to ultimately end up with reliance on more domestic bank borrowing must be replaced by an objective preparation of the budget. It is possible only, if the control of the MoF on other relevant agencies and departments is broken and they participate in preparing estimates on an equal footing.
---- The cabinet should devote more time to the scrutiny of the budget than at present and review it from all angles to make sure that it is consistent with the national economic objectives set by the government at the highest level before its onwards transmission to the NA.
---- These estimates should be subject to scrutiny by a budget office of professional staff set up by the parliament under its own control to provide its objective professional evaluation of the budget estimates to the NA. Similarly, revenue estimates from new tax proposals should be scrutinised and authenticated by the budget committee of the NA before their approval.
---- The MoF should bring to the parliament any deviations in its estimates of revenue and expenditure beyond a certain level on a quarterly basis with specific measures to ensure that budget borrowing does not exceed the already approved limit. The provinces should adopt a similar procedure.
---- The PSEs should be either privatised or run on a commercial basis through their major restructuring, failing which their budgets should be integrated with the regular budget.
---- The final budget accounts of the previous year should be subject to scrutiny by the Auditor General and/or the budget office of the parliament and major deviation from the approved estimates should be reported to the competent authorities with the expectation that those who made original estimates are held accountable for major unexplained deviations.
Failure to introduce such stringent measures to overhaul the process of preparation and implementation of the budget will ultimately take the country to a stage of hyperinflation and external debt default with dire economic, social, political and foreign policy consequences.