Wordfall, by Kaleem Omar

Budget deficits have long been a chronic problem in this country. The deficit for the current fiscal year is expected to go up from the target figure of 3.8 per cent of GDP forecast in June 2005 to over 4.2 per cent of GDP by the time the final figures for fiscal 2005-06 are compiled.

The only surplus budgets this country has ever had were the budgets presented by Liaquat Ali Khan’s government in 1948 and 1949. All the budgets since then have been deficit budgets. The forthcoming budget for fiscal 2006-07, which is expected to be presented before the National Assembly on June 5, is going to be another deficit budget, with the deficit likely to be of the order of over 4 per cent of GDP.

The International Monetary Fund is reported to have expressed concern over the widening budget deficit and has asked the government to seriously look into the issue, failing which Pakistan’s credit rating could be downgraded by international credit rating agencies – making it more difficult for the country to borrow money from foreign lenders.

Although the government stopped seeking financial assistance from the IMF two years ago, after the expiry of the $ 1.4 billion Poverty Reduction Growth Facility Programme in 2004, Pakistan is still required to follow the IMF’s advice under Article IV of the IMF’s Articles of Agreement.

Article IV is the article under which the IMF holds bilateral discussions with member countries usually every year. An IMF staff team visits the country, collects economic and financial information, and discusses with government officials the country’s economic development and policies. On the team’s return to headquarters in Washington, the staff prepares a report, which forms the basis for discussion by the Executive Board. At the conclusion of the discussion, the IMF’s managing director, as chairman of the Executive Board, summarises the views of executive directors, and this summary is transmitted to the country’s authorities.

In recent years, Pakistan has made serious efforts to address its macroeconomic imbalances and deep-rooted structural problems. As a result, some of the country’s macroeconomic indicators have improved, including a reduction in inflation to single digit figures and a significant increase in foreign exchange reserves, which currently stand at about $ 12 billion.

The government has also succeeded in bringing down Pakistan’s overall fiscal deficit from 5.4 per cent of GDP in fiscal 1999-2000 to to 3.3 per cent of GDP in 2003-04. In 2004-5, however, the fiscal deficit began to creep up again. This trend has continued in 2005-06, with the budget deficit for the year now expected to hit 4.2 per cent of GDP.

The reforms of the last few years have also given the State Bank of Pakistan, the country’s central bank, considerable formal independence from the government and a measure of autonomy in implementing monetary policy. But the State Bank is still required to consult with the government on the coordination of fiscal and monetary policy and determining limits of credit to the government. This task is formalized through a credit plan which is agreed after comprehensive discussions with international financial institutions, the government and the State Bank, to ensure consistency with macroeconomic objectives. Subject to this, the State Bank has autonomy in implementing monetary policy.

The State Bank has not recently played a major role in budgetary financing, but it is not prohibited under the law from doing so. Special credit funds are operated by the State Bank to support provision of credit through commercial and development banks to agriculture, industry, exports, and loan guarantees. Each of these credit funds is provided with initial financing through appropriations from the profit of the State Bank determined in consultation with the federal government. All, except the export credit fund, provide credit at commercial rates. Activities of each fund are reported in the State Bank’s Annual Report, but their limited quasi-fiscal activities are not included in fiscal reports. Transparency could be improved by including all fiscal support for such arrangements explicitly in the federal budget.

Another area that needs to be looked at has to do with the fact that no comprehensive overview of the government’s public enterprise borrowing or assets and other equity holdings is maintained. While many government-owned enterprises have been privatized in recent years, scores of commercial and industrial enterprises still remain in the public sector. And the government still retains a substantial equity stake (a majority stake in many cases) even in those enterprises that have been privatized. Thus there is still a need for an annual overview of such holdings.

Pakistan’s economy is still an agriculture-based economy. Agriculture has a 23 per cent direct share in GDP. Its indirect share in GDP is much higher, given the fact that the country’s main industry is textiles, which account for more than 60 per cent of the country’s total exports. Thus, the country’s GDP growth rate depends to a very considerable extent on the performance of the agricultural sector. Yet agricultural income remains outside the direct tax net.

Successive governments have demonstrated an inability to tax agricultural income directly and to ensure tax compliance by all big farmers, many of whom are feudal landlords with large landholdings and powerful political connections. This has resulted in a taxation structure that is both horizontally and vertically inequitable to begin with. This, in turn, has contributed to reduced tax revenues for the government and contributed to the chronic problem of budget deficits.

Another factor that has contributed to budget deficits is the growing cost of maintaining a bloated bureaucracy that keeps getting bigger and bigger by the year. One example will suffice to illustrate the point: in the 1960s, when East Pakistan was still a part of Pakistan, we had 16 government officials of federal secretary rank. Today, with half the country gone, we have more than 150 government officials of federal secretary rank. And the number is even bigger if one includes all the heads of public-sector enterprises.

This bloated bureaucracy not only costs the national exchequer a lot of money, thereby contributing to the budget deficit, it also contributes in no small measure to inefficiency in governance. This inefficiency leads to project delays and higher project costs, which, in turn, result in higher budget deficits. Take the case of the Bolan Medical College and Hospital Complex in Quetta. When the project was proposed in the mid-1970s, its cost was estimated at Rs 70 million. By the time work on the project was completed in the 1980s, however, it had ended up costing over Rs 700 million – ten times the original estimated cost. Such examples of massive cost overruns in public-sector projects are legion. All of them add to budget deficits.

Briefing reporters in Islamabad on January 4 this year after a meeting of the Economic Coordination Committee, the Economic Adviser to the Ministry of Finance, Dr Ashfaq Hassan Khan, said the current account deficit rose to $ 2 billion during the first five months (July to November 2005) of the current fiscal year as compared with $ 130 million during the same period of the previous fiscal year.

He said the increase in the country’s trade deficit was an “Asian phenomenon,” and said it was due to higher imports generated by strong domestic demand and high oil prices in all the regional countries, including Pakistan. Due to this phenomenon, he said, India had a current account deficit of $ 13 billion in the first half of the current fiscal year as against $ 0.5 billion in the same period of the previous fiscal year.

Striking an optimistic note, he said that due to the increase in foreign direct investment (FDI) and portfolio investment in Pakistan in the current fiscal year, there would “not be a huge burden” on the country’s foreign exchange reserves in 2005-06.

Since Dr Ashram Khan made that statement, however, a further sharp rise in oil prices to around $ 70 per barrel and higher imports of capital goods and other items have pushed up Pakistan’s trade deficit to close to $ 9 billion in the first nine months of the current fiscal year. With the trade deficit now growing by an average of about $ 1 billion a month, it is likely to hit $ 12 billion by June 30. The figure could be even higher if crude oil prices rise to over $ 70 per barrel between now and June 30.

The trade deficit for fiscal 2003-04 was $ 3.278 billion. The figure almost doubled to $ 6.213 billion in fiscal 2004-05, and now looks set to almost double again to $ 12 billion in fiscal 2005-06. In theory, a trade deficit of that order would just about wipe out Pakistan’s current foreign reserves of $ 12 billion.

Thus the trend seems to be inexorably upward, and could pose serious problems for the country’s economy in the years ahead unless the government takes urgent steps to boost the country’s exports.

Exports during the first nine months of the current fiscal year were $ 12.073 billion, an increase of 18.6 per cent over exports of $ 10.183 billion in the corresponding period of the previous fiscal year. While this was a fairly healthy increase, imports during the first nine months of the current fiscal year rose by 43.2 per cent to $ 20.693 billion. That is almost 2.5 times the percentage rate of increase in exports.

The government says that higher imports reflect higher levels of economic activity, particularly in the large-scale manufacturing sector. While this may be true, it is also true that Pakistan’s economy cannot continue sustaining a widening trade gap indefinitely. At some point, something’s got to give – and that point may not be too far off if present import trends continue.

The current fiscal year’s trade projected trade deficit of $ 12 billion will be partly offset by about $ 4 billion worth of remittances from overseas Pakistanis. Some offsetting will also come from foreign aid flows (both bilateral and multilateral), which are currently running at an average of about $ 5 billion a year. This, however, will still leave Pakistan with a gap of about $ 3 billion in its national balance of accounts at the end of the current fiscal year.

Moreover, hardly any of the foreign aid received by Pakistan is in the form of grants; most of it is in the form of short-term, medium-term and long-term loans that have to be serviced and repaid. Given this fact, these aid flows cannot be considered money that belongs to Pakistan. If these aid flows of $ 5 billion are subtracted from the equation, the trade deficit burden this year will amount to $ 8 billion. Where is this money going to come from? And where is the money going to come from to finance next year’s trade deficit, and the deficit for the year after that, and the year after that?