Structural contradictions

This year’s budget was prepared and presented under very difficult circumstances. Almost all of last year’s important targets were missed, and by no small margins. Only 2.4 of the targeted four percent growth figure could be achieved.

The fiscal deficit could not be capped at four per cent, and will likely touch six per cent by the time the final numbers are collected.

The only encouraging figures came on the balance of payments front. No doubt the cotton and commodity price burst in the international market provided impetus to our exports, but such trends are usually circumstantial and have been known to turn dramatically.

It is true that last year’s floods and an increasingly difficult security situation severely limited the government’s spending capability, but most problems are structural in nature and likely to outlast the impact of the floods if not corrected immediately.

So the year ended with low growth amid high inflation and subsequent rises in poverty and unemployment levels, a dangerous mix that made this year’s budget preparation that much more difficult for the finance ministry.

The choices available are restricted. The government’s prime focus is on complying with IMF directives and pushing GDP growth to above four per cent. Such aspirations demand an immediate reduction in the fiscal deficit.

And while the government’s desire of slashing it by two per cent indicates it realises what is to be done, the target is unrealistic. A one per cent reduction in one year is more achievable, and would save the ministry any embarrassment it might face when year-end numbers are counted.

We have never been able to achieve a two per cent reduction in one year, even when growth was not trapped in a low trajectory. So, right at the outset, there is a divergence between what must be done, and how the government proposes to achieve it.
On the expenditure side, two main heads are debt servicing and defence allocation. These two combined take up most of the expected revenues, which are usually trimmed as the year rolls on in any case. This means that much of the development and non-development budget will again be financed by increased borrowing. And since more loans will increase the deficit, the exercise is again a self-defeating one.

Double-digit inflation has been a persistent problem for the last five-six years. For it to be contained also, reducing the fiscal deficit is the first order of business. But the government does not seem posturing towards less borrowing, failing which prices are unlikely to come down.

The tax structure is another dilemma. The envisioned 9.3 per cent tax-to-GDP ratio will be extremely difficult to achieve with faltering growth. The government has proved itself a weak coalition unable to make political progress on vital taxation issues. Not only the RGST, but Asset Value Tax could not be materialised. The debate on agriculture tax, too, is nowhere near final decision. Existing taxes are too low for revenue targets and additional taxes cannot be levied. Once again the government is found identifying problems, knowing where to get, but unable to carve the right path.

Pakistan’s unimpressive investment-to-GDP ratio is also a case in point. Currently languishing at 13.5-14 per cent, it used to be around 22 per cent in the early ‘90s, a fair indication of how much social, political and economic conditions have worsened in two decades.

The ratio needs at least a 20 percentage point increase for the five to seven per cent medium term growth the governments wants to pursue.
The interest rate position doesn’t help much. Monetary authorities understand that high rates have failed to arrest inflation, primarily because of excessive government borrowing, and keeping them raised only ensures further crowding out of the private sector. But they are not at liberty to initiate phased reduction owing to IMF complications.
Therefore, the options available do not inspire confidence. There is no outright cure. Concerned quarters can at best juggle combinations to find the most appropriate mix considering constrained resources.

The most immediate concern must be controlling the fiscal deficit. And the first step in that direction is drastically reducing the non development expenditure.
It has become a matter of routine to engineer periodic reductions in the PDSP. From seven per cent in the ‘90s, its share of GDP has come down to around three per cent.

A development budget this low, especially when subject to further reductions, is not enough to stimulate enough growth.

The government needs to re-establish confidence in the business environment. Economic revival will need firm guarantees and positive signals to increase local investment and discourage capital flight. Counting on agriculture prices alone is dangerous. Should the tide turn, the government cannot print foreign exchange to service its needs.
At every step we have noticed structural contradictions between what the government needs to achieve and the methods it is adopting to achieve them. To restore balance in our chronically stagnant economy, it must prioritise targets, beginning with reducing the fiscal deficit.

The writer is a former finance minister.