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This article contends that we will have to learn to live with budget deficits of 6 percent plus of GDP, accept that the economy will grow slowly, that our rate of inflation will be persistently higher than our competitors and that the rupee will continue to be under pressure. And these macro-indicators simply reflect the structural and systemic crises resulting from weak political and economic governance, poor work ethics and deferral of long overdue fundamental reforms.
Getting out of this mess will take some doing. It will be particularly agonising for a new government taking office on heightened expectations. With the future of our balance of payments looking grim, the country will be knocking on the doors of the IMF well before the year is out.
Lets look at the indicators for this year that manifest these structural issues. Following the last NFC Award the provincial share in taxes will be in excess of 63 percent this year, Rs1.2 trillion of the budgeted Rs1.9 trillion, leaving Islamabad Rs100 billion short of the cost of just one expenditure obligation, debt-servicing. This means that, at least for the next two years, the provinces will have neither political nor economic incentives (it is easy to be a populist) to raise additional revenues. This is important since most sectors/activities of the economy (eg agriculture, properties, economic services, etc) that are currently under-taxed, form the tax bases of the provinces under the constitution. These can be taxed productively and effectively using IT and innovative techniques, eg by introducing a single stage (un-adjustable) sales tax at the retail level at a per square feet rate based on location of shop, its size and nature of business.
Since the governance system protects defaulters it compounds the issue of low collections owing to unbridled tax evasion. In other words, growth in tax revenues is constrained by structural factors and bad governance.
The Federal Budget, as always, overestimates revenues receipts from the State Bank, the Americans against the competitiveness support fund (CSF) (for re-imbursement of war on terror expenditures), auction of 3-G licenses, Etiasalat or external inflows from the World Bank, the ADB and bilaterals like USAID, DFID, etc and under provides for expenditures. This merely worsens the environment for the budget deficit and its financing.
Moving to expenditures, defence (on a consolidated basis more than Rs800 billion), requires a fundamental review of our failed frameworks of security state and strategic depth for a reassessment of security related funding requirements.
Next is debt-servicing of close to Rs800 billion (much of which is of loans that financed physical infrastructure in the provinces) which requires that Islamabad should in future only be constructing inter-provincial infrastructure and not, say, provincial roads and local water supply schemes. The next major expenditure item is subsidies, starting with imported fertiliser (whose bill this year will cross Rs50 billion, while the budget allocates nothing for it) and the cost of trading operations of agricultural commodities like wheat, cotton and sugar simply to please powerful lobbies (which for the last two could cost more than Rs10 billion this year with nothing earmarked in the budget).
These functions/bills should be performed/picked up by the provinces whose farmers are being subsidised and who are supposed to pay taxes on their incomes to the respective provincial government. Islamabad should be getting out of this business and close down agencies like TCP and PASSCO, which are also dens of corruption.
Next there are the power subsides costing Islamabad Rs7 lacs per minute (more than Rs1 billion a day compared with the budgeted amount of Rs50 billion for the entire year), because of a) the provision of free electricity to Wapda employees; b) expensive fuel mix (a subject of a separate debate); c) lower tariff than cost of electricity production to consumers of 100 kwhs; d) power theft (in collusion with employees of the distribution companies); e) unmetered supply; f) government departments and the private sector not paying bills and still not being disconnected; g) and Rs35 billion worth of free provision of electricity to Fata and tube well owners in Balochistan (the political repercussions of eliminating such subsidies should be obvious).
Addressing this requires both an adjustment of pricing for power and gas especially CNG (easier said than done) and the provision of electricity at a uniform rate at the entry point of all provincial boundaries with the distribution companies being handed over, in a phased manner, to the provincial governments or being privatised on agreed parameters. And finally there is the PIA, the Railways and Steel Mills losing Rs2 lacs a minute. They will have to be bailed out repeatedly unless we can reduce their overstaffing and tackling their governance issues, with privatisation the only pragmatic solution; all such initiatives being politically intimidating.
Then there is the oversized state structure represented by the civil bureaucracy (even after the 18th Amendment, under which several functions have been transferred to the provinces) whose weight is still being shouldered by the federal government with no prioritisation of functions that the state should retain and pay from the public purse.
And these adjustments need to be supplemented with greater austerity, requiring abandoning of VIP planes, bullet-proof and luxury cars, opulent housing, subsidised plots and facilities, Haj, Umrah, etc for public representatives and functionaries and government expense (replacing it with the monetisation of all perks), economy class travel on flights less than five hours, etc.
The reasons, plagued by misgovernance, we will have to learn to live with budget deficits that are likely to exceed 6 percent of the GDP in the foreseeable future. Financing deficits of such magnitude Rs1.3 trillion for this year would be a daunting proposition even at the best of times, which is not the case today.
In my view, for a variety of reasons (ranging from the tension in relations with the Americans to failure to stay the course on the IMF programme) inflows from abroad cannot in the foreseeable future be enough to finance a significant share of the budget deficit, while those holding cash will not easily part with it because they are earning returns (from speculative, or other, activities) that are higher than those that will be on offer on financial instruments of the National Savings Schemes (especially after the recent 200 basis point reduction in interest rates).
Therefore, a substantial share of the financing of such large budget deficits will have to come from the commercial banks if the State Bank is not to be called upon to print more photographs of the Quaid.
However, when the government seeks more funds from commercial banks to finance its huge budget deficit it crowds out the private sector, in particular the more labour intensive small and medium sized enterprises struggling to survive without adequate supplies of reliable energy at affordable rates. With the sovereign queuing up for money the risk-averse banking sector will understandably lend to the government rather than to private businesses.
Since June 2008 banks holdings of government securities have more than tripled, from Rs790 billion to Rs2,515 billion. It is staggering that since 2008 the share of the private sector in bank credit has declined from 61 percent to below 46 percent. That the private sector is also unwilling to dilute its ownership or does not have the market credibility to raise funds from non-banking sources (it is note-worthy that Rs1.7 trillion, 33 percent of rupee deposits, is currency in circulation) merely aggravates the conditions for investment and production, which provides one of the explanations why we will continue to see economic growth settling at a low-level equilibrium.
Unfortunately for Islamabad, even if it takes the bulk of the increase in deposits from the banking system (this year it will essentially be the interest earned on existing deposits and not new deposits) with all its implications for private investment and production), it will fall short of funds required to finance the budget deficit. In other words, the State Bank will have little choice but to print money, which will have its own inflationary consequences. Hence my argument that a significant proportion of the inflation that we will experience going forward will be for structural reasons.
With our inflation likely to be higher than that of our trading partners or competitors, our manufacturing sector, already struggling to maintain production volumes given acute energy shortages, will find it difficult to compete internationally with a rising cost curve. This will make imports cheaper at the prevailing exchange rate, at least in the short-term, widening the trade deficit. Financing and narrowing it will not be sustainable without an adjustment in the value of the rupee. This continuing pressure on the rupee will, therefore, also be an outcome of the imbalances requiring structural adjustments for pushing the economy onto a higher growth path and thereafter nourishing it so that it can accommodate the burgeoning population of the youth looking for gainful employment opportunities.
And, in the short-term, a strategy for easing the stress on the balance of payments may well have to include higher LC margins, regulatory duties on imports, etc.
The arguments above have attempted to demonstrate that the issues relating to revenue mobilisation and seemingly uncontrolled expenditures are not specific to this financial year but are structural in nature. They can only be tackled over time and through painful reforms of a fundamental nature (along the lines proposed above) since we as a nation have been living on borrowed time, way beyond our means for far too long.
Distributing this pain equitably, based on the ability of the different socio-economic groups to bear the burden of adjustment, will test the capability and the resolve of our political leadership, an aptitude that it has not shown hitherto.
Written by Shahid Kardar
The writer is a former governor of the State Bank of Pakistan.
Coping with structural imbalances - Shahid Kardar
Getting out of this mess will take some doing. It will be particularly agonising for a new government taking office on heightened expectations. With the future of our balance of payments looking grim, the country will be knocking on the doors of the IMF well before the year is out.
Lets look at the indicators for this year that manifest these structural issues. Following the last NFC Award the provincial share in taxes will be in excess of 63 percent this year, Rs1.2 trillion of the budgeted Rs1.9 trillion, leaving Islamabad Rs100 billion short of the cost of just one expenditure obligation, debt-servicing. This means that, at least for the next two years, the provinces will have neither political nor economic incentives (it is easy to be a populist) to raise additional revenues. This is important since most sectors/activities of the economy (eg agriculture, properties, economic services, etc) that are currently under-taxed, form the tax bases of the provinces under the constitution. These can be taxed productively and effectively using IT and innovative techniques, eg by introducing a single stage (un-adjustable) sales tax at the retail level at a per square feet rate based on location of shop, its size and nature of business.
Since the governance system protects defaulters it compounds the issue of low collections owing to unbridled tax evasion. In other words, growth in tax revenues is constrained by structural factors and bad governance.
The Federal Budget, as always, overestimates revenues receipts from the State Bank, the Americans against the competitiveness support fund (CSF) (for re-imbursement of war on terror expenditures), auction of 3-G licenses, Etiasalat or external inflows from the World Bank, the ADB and bilaterals like USAID, DFID, etc and under provides for expenditures. This merely worsens the environment for the budget deficit and its financing.
Moving to expenditures, defence (on a consolidated basis more than Rs800 billion), requires a fundamental review of our failed frameworks of security state and strategic depth for a reassessment of security related funding requirements.
Next is debt-servicing of close to Rs800 billion (much of which is of loans that financed physical infrastructure in the provinces) which requires that Islamabad should in future only be constructing inter-provincial infrastructure and not, say, provincial roads and local water supply schemes. The next major expenditure item is subsidies, starting with imported fertiliser (whose bill this year will cross Rs50 billion, while the budget allocates nothing for it) and the cost of trading operations of agricultural commodities like wheat, cotton and sugar simply to please powerful lobbies (which for the last two could cost more than Rs10 billion this year with nothing earmarked in the budget).
These functions/bills should be performed/picked up by the provinces whose farmers are being subsidised and who are supposed to pay taxes on their incomes to the respective provincial government. Islamabad should be getting out of this business and close down agencies like TCP and PASSCO, which are also dens of corruption.
Next there are the power subsides costing Islamabad Rs7 lacs per minute (more than Rs1 billion a day compared with the budgeted amount of Rs50 billion for the entire year), because of a) the provision of free electricity to Wapda employees; b) expensive fuel mix (a subject of a separate debate); c) lower tariff than cost of electricity production to consumers of 100 kwhs; d) power theft (in collusion with employees of the distribution companies); e) unmetered supply; f) government departments and the private sector not paying bills and still not being disconnected; g) and Rs35 billion worth of free provision of electricity to Fata and tube well owners in Balochistan (the political repercussions of eliminating such subsidies should be obvious).
Addressing this requires both an adjustment of pricing for power and gas especially CNG (easier said than done) and the provision of electricity at a uniform rate at the entry point of all provincial boundaries with the distribution companies being handed over, in a phased manner, to the provincial governments or being privatised on agreed parameters. And finally there is the PIA, the Railways and Steel Mills losing Rs2 lacs a minute. They will have to be bailed out repeatedly unless we can reduce their overstaffing and tackling their governance issues, with privatisation the only pragmatic solution; all such initiatives being politically intimidating.
Then there is the oversized state structure represented by the civil bureaucracy (even after the 18th Amendment, under which several functions have been transferred to the provinces) whose weight is still being shouldered by the federal government with no prioritisation of functions that the state should retain and pay from the public purse.
And these adjustments need to be supplemented with greater austerity, requiring abandoning of VIP planes, bullet-proof and luxury cars, opulent housing, subsidised plots and facilities, Haj, Umrah, etc for public representatives and functionaries and government expense (replacing it with the monetisation of all perks), economy class travel on flights less than five hours, etc.
The reasons, plagued by misgovernance, we will have to learn to live with budget deficits that are likely to exceed 6 percent of the GDP in the foreseeable future. Financing deficits of such magnitude Rs1.3 trillion for this year would be a daunting proposition even at the best of times, which is not the case today.
In my view, for a variety of reasons (ranging from the tension in relations with the Americans to failure to stay the course on the IMF programme) inflows from abroad cannot in the foreseeable future be enough to finance a significant share of the budget deficit, while those holding cash will not easily part with it because they are earning returns (from speculative, or other, activities) that are higher than those that will be on offer on financial instruments of the National Savings Schemes (especially after the recent 200 basis point reduction in interest rates).
Therefore, a substantial share of the financing of such large budget deficits will have to come from the commercial banks if the State Bank is not to be called upon to print more photographs of the Quaid.
However, when the government seeks more funds from commercial banks to finance its huge budget deficit it crowds out the private sector, in particular the more labour intensive small and medium sized enterprises struggling to survive without adequate supplies of reliable energy at affordable rates. With the sovereign queuing up for money the risk-averse banking sector will understandably lend to the government rather than to private businesses.
Since June 2008 banks holdings of government securities have more than tripled, from Rs790 billion to Rs2,515 billion. It is staggering that since 2008 the share of the private sector in bank credit has declined from 61 percent to below 46 percent. That the private sector is also unwilling to dilute its ownership or does not have the market credibility to raise funds from non-banking sources (it is note-worthy that Rs1.7 trillion, 33 percent of rupee deposits, is currency in circulation) merely aggravates the conditions for investment and production, which provides one of the explanations why we will continue to see economic growth settling at a low-level equilibrium.
Unfortunately for Islamabad, even if it takes the bulk of the increase in deposits from the banking system (this year it will essentially be the interest earned on existing deposits and not new deposits) with all its implications for private investment and production), it will fall short of funds required to finance the budget deficit. In other words, the State Bank will have little choice but to print money, which will have its own inflationary consequences. Hence my argument that a significant proportion of the inflation that we will experience going forward will be for structural reasons.
With our inflation likely to be higher than that of our trading partners or competitors, our manufacturing sector, already struggling to maintain production volumes given acute energy shortages, will find it difficult to compete internationally with a rising cost curve. This will make imports cheaper at the prevailing exchange rate, at least in the short-term, widening the trade deficit. Financing and narrowing it will not be sustainable without an adjustment in the value of the rupee. This continuing pressure on the rupee will, therefore, also be an outcome of the imbalances requiring structural adjustments for pushing the economy onto a higher growth path and thereafter nourishing it so that it can accommodate the burgeoning population of the youth looking for gainful employment opportunities.
And, in the short-term, a strategy for easing the stress on the balance of payments may well have to include higher LC margins, regulatory duties on imports, etc.
The arguments above have attempted to demonstrate that the issues relating to revenue mobilisation and seemingly uncontrolled expenditures are not specific to this financial year but are structural in nature. They can only be tackled over time and through painful reforms of a fundamental nature (along the lines proposed above) since we as a nation have been living on borrowed time, way beyond our means for far too long.
Distributing this pain equitably, based on the ability of the different socio-economic groups to bear the burden of adjustment, will test the capability and the resolve of our political leadership, an aptitude that it has not shown hitherto.
Written by Shahid Kardar
The writer is a former governor of the State Bank of Pakistan.
Coping with structural imbalances - Shahid Kardar
