KARACHI – The State Bank of Pakistan (SBP) has said that the failure of tax reforms programme and the flood relief expenditures have rendered the fiscal imbalance of Pakistan unsustainable. The SBP issued this stunning disclosure in its second quarterly report for 2010-11.
The report said that although fiscal indicators showed some improvement in the second quarter of FY11 with substantial growth in non tax revenues, the overall fiscal position during H1-FY11 deteriorated. Consequently, the fiscal deficit increased to 2.9 percent of GDP from 2.7 percent in the same period last year. Persistent growth in expenditures driven primarily by flood relief activities and failure to implement tax reforms, have rendered the fiscal imbalance unsustainable, report observed.
As such, achieving the deficit target of 4.7 percent set for FY11 seems highly unlikely in the absence of a clear strategy to increase the tax base by bringing untaxed sectors into the tax net; there is also a need to rationalise electricity tariffs and subsidies on POL product. Financing the deficit has become all the more challenging in the absence of external financing due to non-observance of IMF conditions on fiscal consolidation.
The government, as a result has resorted to heavy borrowing from the banking system, which in turn has not only exerted pressure on short-term interest rates, but also has adverse implications for inflationary expectations, private sector credit and overall macroeconomic stability. The only way out for the government is to show political will to prioritise its expenditure heads and implement tax reforms aimed at removing tax exemptions e.g., taxing agriculture and services.
Even if this does not deliver immediate tax revenues, it would close the door on tax avoidance. As noted in SBP’s first Quarterly Report for FY11, the restraint in spending exercised during this period was unsustainable. There were risks that spending limits at the federal and provincial level would be breached; this materialised in the second quarter of FY11.
The ratio of total expenditures to GDP rose to 8.6 percent in the first half of FY11, which was relatively lower than the level observed in the same period last year. The report also underlined that at the federal level; about 69.5 percent of the increase in spending was driven by defense, running of the government and net lending activities.
Expenses under the running of the government head increased 23.4 percent annually, mainly reflecting the impact of higher salaries and allowances for federal government employees in the FY11 budget. Additionally, flood relief measures claimed an unbudgeted 2.7 percent of consolidated public expenditures during H1-FY11.
At the provincial level, both current and development spending recorded a hefty increase in Q2-FY11 which largely offset transfer of resources to provinces under the 7th NFC award. Due to a sharp rise in expenditures, the consolidated fiscal surplus of provinces dropped from 0.5 percent in Q1-FY11 to 0.1 percent of GDP during Q2-FY11.
As the government moves forward with its agenda to transfer key ministries to provinces under the 18th Amendment, the fiscal balance could deteriorate further in the absence of strict discipline on spending. Development spending remained conspicuously low in H1-FY11. Although some improvement was visible on a quarterly basis in Q2-FY11, the overall level of spending was 18.3 percent lower than average PSDP spending recorded during July-December in the Financial Years 2006-10.
In nominal terms this implies that real spending is sharply down. Distressingly, spending for PSDP as percent of GDP is at the same level as expenditure on war on terror, and provision of loans and subsidies to the power sector during H1-FY11. Total revenues increased by 8.8 percent annually to Rs. 989.6 billion during H1-FY11.
Majority of this increase was attributable to: (1) advance income tax payments under the head of direct taxes; and, (2) growth in taxes on goods. However, revenues from the petroleum development levy declined annually as the prices of POL products have grown on average in H1-FY11 resulting in weaker sales of High-Speed Diesel (HSD) and Kerosene.
Growth in non-tax revenues dampened somewhat, largely due to a decline in transfer of SBP profits. Receipts under the head of dividends showed a decline for the second consecutive year, due to lower earnings of public sector institutions and delay in dividend income receipts from these institutions.
Receipts under the head of defense, however, increased appreciably in H1-FY11compared to the same period in the last five year as US$743 million were received on account of logistics support. According to the report, within overall revenues, FBR tax collections registered a growth of 13.7 percent annually during H1-FY11, as compared to 5.1 percent in the corresponding period of the previous year.
Although this increase appears to be significant, FBR will have to collect Rs 942.7 billion in H2-FY11 to meet its end-year target. This amounts to a growth of 26.3 percent over collections in H2-FY10. Although tax collection tends to improve significantly during the second half of a fiscal year, this target may be difficult to achieve.
