Creating fiscal space to stimulate economic activities

Written By M. Sharif

Contrary to providing fiscal stimulant for providing boost to economic activities during last three years, the government ended up doing the exact opposite by increasing prices of various inputs required by industrial and agriculture sectors and reducing spending on crucial development projects under the Public Sector Development Programme (PSDP). The government projected PSDP expenditure for current fiscal year at Rs663 billion (4.4 per cent of the GDP) as compared to Rs510 billion (3.3 per cent of the GDP) in FY 2009-10, with a rise of 30.0 per cent according to revised estimates. The federal PSDP was kept at Rs280 billion for current fiscal year. Meanwhile, the provincial programme was estimated at Rs373 billion as against Rs200 billion in the revised estimates for the same time period. The federal development expenditure of Rs280 billion has been slashed to Rs180 billion that has stalled a large number of development projects to reduce the surging fiscal deficit. A number of significant development projects in health and education have been gravely affected by the government action.

The federal government is financing projects worth Rs150 billion through domestic resources, while projects amounting to Rs30 billion are expected to be supported by donors. Plunge in PSDP expenditure by the ruling party is not an unusual practice to tackle the issue of burgeoning fiscal deficit. In FY 2009-10 a heavy amount of Rs646 billion was allocated for PSDP but by end of the year, it stood at less than Rs400 billion.

Development projects of the provinces have also been hard-hit on account of less than anticipated transfer of funds to them under National Finance Commission (NFC) award because of a sharp fall in tax revenue, constrained inflows from IMF and the US that were to help curtail high fiscal deficit and support the federal government in financing its development programmes, hike in pubic expenditure due to higher cost of security and maintaining deteriorating law and order situation and service ballooning public debt. Partial diversion of development funds by the federal and provincial governments towards rehabilitation of flood-affected areas and individuals also squeezed the funds for initiating developmental projects. All these factors have reduced the prospects of enhancing economic growth to around 2.5 per cent against the projected target of 4.5 per cent for this fiscal year.

According to the Medium Term Budgetary Framework (MTBF) (2010-13), PSDP is to crawl up to 5.2 per cent during FY 2011-12 and subsequently to 6.0 per cent during 2012-13. It would be difficult to provide financial support to the programme in view of the dismal state of financial affairs with respect to generation of insufficient tax revenue by Federal Board of Revenue (FBR) and heavy public resistance to improve tax revenue collection through imposition of RGST. FBR’s tax revenue collection, as observed by MTBF, is to rise from last year’s figure of 9.0 per cent to 9.8 per cent by the conclusion of current fiscal year. After that it is predicted to touch 10.5 per cent during FY 2011-12 and then 11.1 per cent by FY 2012-13. Keeping in mind the prevailing financial crunch confronting the economy, these targets seem hard to achieve. Inability to expand tax revenue compelled the central bank to pursue expansionary fiscal policy. This fuelled inflation and created an environment for SBP to adopt tight monetary policy stance that has pushed discount rate to 1,400 bps. It resulted in a fragile growth rate of less than 3.0 per cent in last three years. The situation is unlikely to improve next financial year.

The macroeconomic framework being envisaged for the forthcoming fiscal year is still to materialise on the back of lack of economic resources and devolution of 18 ministries out of 40 to provinces by the end of this year. Therefore, bearing in mind the abovementioned reasons the ministry of finance is stipulating a macroeconomic framework of about Rs280 billion for the next year. It is equivalent to the amount that was initially projected for current fiscal year. The Planning Commission demands an allocation of Rs365 billion in line with MTBF goals. The political leadership had targeted PSDP expenditure of Rs465 billion and Rs591 billion for FYs 2012-13 and 2013-14 respectively. It would be an uphill task to meet the financing targets unless there is a substantial upsurge in tax revenue collection, cutback in law and order expenditure and the provinces observe financial discipline and raise their share of development expenditure.

Fiscal resources are constrained owing to a variety of reasons, such as:

* Lack of political will on part of the ruling regime and its coalition partners to develop a consensus on difficult economic and fiscal reforms that are urgently required, including systematic tax reforms. This is primarily the reason why a trust deficit has been created between multilateral institutions and the government, thereby leading to no or limited inflow of funds.

* The stalled IMF loan programme due to the centre’s  inability to impose RGST, pursue power sector reforms, give greater autonomy to the SBP and improve commodity operations which are urgently needed to eliminate financial losses that impose a burden on the national exchequer and pose a threat to macroeconomic stability.

* Adverse security developments that continue to hurt domestic and foreign investors.

* Continued expansionary fiscal policy that has an adverse impact on macroeconomic stability and has crowded out private sector borrowing from commercial banks. The commercial banks are more than ecstatic to lend to the government for securing high profits.

* High cost of debt servicing that consumes around 44 per cent of tax revenue collected by FBR. Official aid from multilateral institutions and friendly governments has turned negative at present. According to data for the last financial year, the government received $4.143 billion against payment of $5.107 billion coupled with a payment of $0.964 billion to external donors. This left the government high and dry for financing developmental projects. The situation would not improve anytime soon.

* The ruling elite overestimated high financial and budgetary support from foreign donors. However, the flow of funds to the country remained sluggish with the result that the government resorted to excessive printing of currency. It fuelled inflation and augmented fiscal deficit.

The financial managers of the country ought to put the economic house in order with a prime focus on creating fiscal space to stimulate economic activities. It should keep the following points in mind:

* Concerted efforts should be made to reduce non-productive expenditure and extraordinary steps be taken in the forthcoming budget to increase revenue through taxing farm income, real estate, and services sector. Measures should also be taken to levy wealth tax and make the tax system equitable.

* Loss-making public-sector enterprises need to be revamped for curtailing subsidies paid to them.

* End user-subsidies should be eliminated and targeted subsidies be provided to those segments of society who really need them.

* Instead of setting exceedingly ambitious economic targets, they should be realistic and attainable so that their downward revision is not necessitated.

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