The state of economy

According to newspaper reports, Federal Finance Minister Dr Hafeez Sheikh pleaded with all the key power players in the country, including the military, to demonstrate ‘fiscal responsibility’ to avert what he reportedly referred to as a ‘complete economic breakdown.’

The plea was made on August 26, prior to his departure to Washington DC to attend crucial meetings with the International Monetary Fund (IMF) at the conclusion of the stipulated quarterly review under the Stand-By Arrangement as well as to request for additional assistance in the aftermath of the devastating floods.

Dr Sheikh, at the meeting, described the state of the economy prior to the floods as ‘teetering on the brink.’ Two things went horribly wrong last year that may account for this assessment. First and foremost the obvious contradiction between the National Finance Commission Award, effective from the current year, with larger share of the pie to the provinces without a concomitant responsibility to shoulder increased burden of expenditure and the nation-wide resistance to the implementation of a value added tax due to the failure of the economic team led by Shaukat Tarin to take the stakeholders on board. These two issues unless resolved amicably may compromise the government’s revenue collection targets for 2010-11 though they did not impact on the revenue targets for last year.

Talks are ongoing with the Sindh government and Dr Sheikh has repackaged VAT as reformed GST which maybe acceptable to stakeholders given that GST is already being collected. His success in increasing documentation of the economy, a major outcome of VAT, may however not be achieved in the short-term. What is significant is that according to the budget documents total actual revenue collected in 2009-10 in contrast to the budgetary estimates had a shortfall of 197.635 billion rupees. This is partly attributed to the failure of the pledges made at the Friends of Democratic Pakistan to be fulfilled, partly due to the failure of the government to improve governance within the Federal Board of Revenue and partly due to continuing a tax structure considered unfair, inequitable and anomalous.

In this context, it is relevant to note that the then Finance Minister repeatedly stated that the Federal Board of Revenue was one of the most corrupt institutions in the country and constantly exhorted his cabinet colleagues to follow PPRA rules to ensure good governance. He also formulated an austerity plan which he submitted prior to his resignation. This is Tarin’s legacy and one would hope that the incumbent does not ignore these critical revenue generation aspects.

That improved tax collections remains an IMF concern can be gleaned from the recent statement by IMF chief Strauss-Kahn during the recent joint press conference with Dr Sheikh, “we’re discussing now how to reorganise the programme owing to the new circumstances. What is important is what was decided by the government to improve the economic situation, especially in the tax sector, but in other fields, as well”. There is an urgent need therefore for the government to formulate a fair tax system by ending exemptions to the rich, reduce corruption in FBR through random audits and ensure strict compliance of PPRA rules.

Second and equally important from the perspective of fiscal responsibility is the fact that expenditure was not curtailed, and even though the unrealistically high budget allocation for development expenditure in 2009-10 was reduced by over 130 billion rupees yet the country failed to meet its deficit target. The IMF was compelled as a result to agree to a deficit target of 4.9 percent which was again revised upward by 0.2 percentage points at the end of last fiscal year. According to budget documents, expenditure overshot the budgetary target by 123.247 billion rupees, due to higher costs of fighting the war on terror as well as continued heavy borrowing by the provinces.

So where did this money, to bridge the gap between the decline in revenue and rise in expenditure come from in 2009-10? Borrowing rose once again and floating debt consisting of prize bonds and treasury bills jumped from the 2009-10 budgetary estimates of 11 billion rupees to 94.8 billion rupees.

In the current year, however, the NFC Award has become effective and envisages an increase in the share of the divisible pool – from 47.5 percent to 56 percent – which accounts for a rise of 366.2 billion rupees in transfer to provinces in the current year’s budget – or that much less is available for the federal government. Reports from the Finance Ministry carried by this newspaper also note that the federal government has refused to extend assistance for provincial development projects, other than the special packages announced by the Prime Minister and the President and the Balochistan Package.

Dr Sheikh has rightly urged fiscal responsibility on all major players. But he needs to take some steps as well including controlling expenditure and increasing revenue. If the government is to continue the war on terror, and the fact that assistance from several countries is linked to this decision, then military expenditure is unlikely to be curtailed anytime soon. In addition, debt servicing will continue to account for another major chunk of annual expenditure. That leaves development and non-development expenditure. Business Recorder has been arguing in favour of cutting down all unnecessary current expenditure including the large annual bail-out packages that are by now routine to badly managed state-owned entities. Development budget as well as current expenditure must be curtailed with greater emphasis on the latter. – Brecorder