How to control Fiscal and Current Account Deficits in Pakistan

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With new Government having Assad Umar as Finance Minister with Economic Advisor and member of Economic Advisory Committee based on the same persons (like Dr Ishrat, Syed Saleem Raza etc. etc.) that served Musharraf government causing economic crisis in 2005 and 2008 with flow of capital outside Pakistan are now trying to cap the inefficiencies and irregularities of the economy.

Immediate problems are highly bulged twin deficits i.e. current and fiscal deficits. In fact both are two faces of the same coin. For this PTI government is now approaching IMF after lot of U Turns. It is astonishing to note that whole Economic Advisory Committee backed Asad Umar to approach IMF except one i.e. Dr Ashfaq Hassan.

In simple words look for budget 2018-19. Half of it has been consumed by debt repayments/interest payments plus expenditure on defense. To run the country it needs further borrowing of Rs 2-3 trillion.

What happens that additional amount brought through fiscal deficit enters in to the market enhancing demand capacity of the market that shifts towards increase in imports creating current account deficit. In simple words this requires raising revenue as well, reducing import and increasing exports. But for the procurement of these objectives lot of structural reforms are required. In other words to get $ 9-12 billion to smooth out economy by approaching IMF, the game of bringing reforms would get in our life with its short term consequences.

Some of our experts say that with changing regional groupings we can get out of economic crisis but in realty this is a world of give and take. From the export/import data (Table 1) it is revealed that we are in advantage only with European countries in export and import business. With China, Far East and Islamic countries we are at significant loss.

The combination of economic activity and low inflation always give two important implications. First, it boosts confidence in the economy, which along with affordable cost of financing induces firms to borrow substantially. In particular, energy, textiles, and cement sectors can focus more on capacity expansion to gear up for growing domestic demand. A healthy rise in working capital isalso required; while the consumer finance posted in the last 12-years has remained driven mainly by a surge in auto and housing finance.

The second impact relates to increase in consumption, which along with recovering oil prices, further inflated the import payments. Higher import bill, despite consecutive months of exports growth and rising workers’ remittances, resulted in record widening of current account deficit. Even higher financial inflows from IFIs, bilateral sources, and issuance of sovereign bonds remained insufficient. Thus, the remaining payment gap fell on the country’s FX reserves, which fell to only one and a half month of import cover in 2018. The foreign exchange market also remained volatile and PKR depreciated from Rs 108 per dollar to Rs 138 per dollar. Now a PTI Minister has predicted that soon it would cross Rs 140 per dollar.

These external sector developments have started to impact inflation as well. The pass-through of rising global oil prices to domestic fuel prices pushed up the energy component of inflation, as the government passed on its impact to consumers. Similarly, the impact of PKR depreciation has started to translate into costly imports and shoring up of inflationary expectations.

On the fiscal side, the healthy growth in revenue could not keep up pace with a sharp rise in fiscal expenditure. Particularly, the development expenditure related to infrastructure and power projects increased sharply, with major contribution coming from provinces. As a result, the fiscal deficit in FY 2018 stood higher than corresponding period last year.

To finance the fiscal gap, the government had to rely both on SBP’s borrowing and external sources. External debt, owing both to higher commercial loans and revaluation impact of the PKR depreciation has also risen considerably.

In short, ensuring the continuity of expansion in economic activities and low inflation would depend on containing of current account and fiscal deficits. As these vulnerabilities are posing challenges to Pakistan’s current growth cycle, implementation of both short-term and medium term policies would be crucial in this regard.

The resulting higher fiscal deficit was largely financed through borrowing from SBP and external sources. In case of external financing, government heavily relied on commercial loans and sovereign bonds. Moreover, the revaluation losses, resulting from appreciation of major currencies against US$ and the depreciation of rupee against US$ also added significantly to external debt. Overall, these developments led to considerable increase in public debt, with record accumulation.

The government has earlier set a 6.2 percent real GDP growth target for FY19 largely on the back of accelerating growth momentum of the last few years. Higher PSDP and CPEC spending, further ease in power supply and continuation of industrial expansion plans are other reassuring factors. However, the growing external vulnerability and high fiscal deficit will continue to pose major down side risks to the achievement of this target. Moreover, on the real side, the ongoing dry spell and water shortages may adversely impact the value addition potential of the agriculture sector.

High domestic demand, lagged impact of adjustment in energy prices, and PKR depreciation are likely to contribute to higher CPI inflation in FY19. Smooth supply of staple food items and soft oil price on the other hand could offset these underlying pressures and help keep inflation around the target of 6-7 percent set for FY19.

The government has set fiscal deficit target at 4.9 percent of GDP for FY19, which is based on a 12.7 percent anticipated growth in FBR tax revenues and a 10.0 percent increase in expenditures, with greater emphasis on current expenditure. While the current budget has reduced tax rates (now raised again by Assad Umar in his mini budget) without rationalizing expenditure, achieving the fiscal deficit target in this backdrop appears challenging.

On the external side, the exports growth prospects remains encouraging on the back of PKR depreciation; recovery in global demand; fiscal incentives for exports; ease in power supply; and improved price outlook of rice and cotton in the international markets. Also, the growth in workers’ remittances is expected to further gather some pace, partly on account of the steps taken by the government and SBP to attract inflows through the official channels. At the same time, a deceleration in imports is expected due to PKR depreciation and the continuation of administrative measures to dampen the domestic demand for non-essential import items.

However, the import bill is likely to stay high owing to a notable increase in international commodity prices, especially of oil. This would keep the trade deficit high in FY19 as well. Furthermore, the FDI inflows are expected to remain lower in FY19 than last year as a number of CPEC energy projects are in their advance stages of completion. Therefore, in overall terms, the high current account deficit, together with limited financial inflows, would continue to keep the balance of payments under pressure.

In short-term, concerted efforts could be made to rationalize fiscal expenditures through following steps-

  1. By increasing tax net not on the basis of withholding tax on banking transactions or sale purchase of property. For this as first step tax legislation is required for services sector, Agriculture sector, Whole sale and Retail sector.
  2. Secondly reforms in FBR are required i.e. to ask it to raise direct tax by using NADRA data. In the medium term, reforms would be needed to expand tax base besides enhancing efficiency of the existing system.
  3. The slowdown in revenue collection was primarily due to direct taxes. More specifically, the drag came from a decline in voluntary payments, while withholding taxes and collection on demand increased considerably compared to last year. The decline in voluntary payments can partially be attributed to reduction in corporate tax rate (It is reported that due to such rates corporate sector conceal 60% of its taxable income) and lower bank profitability. Meanwhile, growth in indirect and provincial taxes remained buoyant in line with expanding economic activity, and the pass-through of rise in the oil prices to domestic consumers. The non-tax revenue also recovered strongly, bolstered by a jump in provincial non-tax revenue, higher markup payment, dividend income and PTA /postal service profit.
  4. Simultaneously, there is a need to arrange external financing in the short term.
  5. To raise external flows instead of making rhetoric of bringing looted money from outside, emphasis should be made to export manpower to GCC at least with one to two lac persons. Qatar has promised to import one lac man power from Pakistan but for this strict follow up is required. This can raise the Remittance to at least $ 21 billion from current $ 18 billion.
  6. For government borrowing government needs to replace current Public Debt Act of 1944 with new government securities Act to use alternative methods for government borrowing. The writer can provide a fresh draft to the government duly approved by the legal firms.
  7. For development expenditure it should be made mandatory that its 80% has to be used on education, health, clean water and keeping streets clean.
  8. Also, more policy measures are required to contain the widening trade deficit. For this purpose, it is also crucial to resolve structural issues affecting exports competiveness.

Hence from a fresh slate, government has to do its work that with the present team looks not likely to happen. So Government should bring a formidable team not based on already tried persons.

Table 1
Export Receipts by Commodity

$ in millions

Imports by Commodity

$ in millions

2016 2017 2018 2016 2017 2018
Foods Total (Prominent Rice) 3,722 3,618 4,793 Food group 4,600 5,417 5,499
Textile  (prominent Yarn, cloth, knitwear, bed wear, readymade garments) 12,756 12,456 13,344 Machinery 7,097 7,410 8,703
Petroleum products (Main solid fuel) 450 411 575 Transport 1,861 2,643 3.206
Manufacturing products 3,805 3,659 4,121 Petroleum group 8,360 10,607 13,263
others 1,084 1,219 1,387 Textile 3,155 3,589 4,049
Total Exports 21,817 21,363 24,220 Agriculture/Chemical 6,715 7,123 8,310
Metal 3,663 3,674 4,781
Rubber/wood/Jute/paper 999 1,196 1,255
others 3,914 5,620 5,382
Total Imports 40,964 47,279 54,448
Four Main Regions For Exports/Imports $ in millions
Regions 2016 2017 2018 Regions 2016 2017 2018
GCC 2279 2148 2591 GCC 10,388 126,93 16,056
China/Japan/Korea 2632 2363 2456 China/Japan/Korea 11,869 13,188 14,995
Europe 7074 7295 8318 Europe 5600 6303 7715
South Asia Malaysia/Indonesia/

Thailand/

Singapore

981 1087 1356 South Asia 9malaysia/Indonesia/

Thailand/Singapore

5989 7011 7904
Table 2 Important Data
FY 2016 FY 2017 FY 2018
Real GDP growth % market prices 5.5 5. 7 5.4 *
CPI (YOY)% 3.4 5.8 *
Tax revenue –FBR Rs in billions 3,112 4,937 5,228
Policy Rate 5.75 6.0 8.50
SBP’s reserves (end-period) $ in billions 18.112 16.144 10.211
Worker remittances $ in billions 19.351 19.625
FDI in Pakistan $ in billions 1.8 2.0 2.1
Current account balance  $ in billions  -12.621 -18.130
Fiscal balance deficit % -4.6 – 5.8 – 6.6%
Current account balance % of GDP -4.1 -5.8
Foreign Investment $ in billions 2.663 2.760
*After getting funds from IMF Real GDP growth would come down below 4.0% and CPI would go above 7%

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