Prime Issue of Pakistan-Fiscal and Current Account Deficits

Immediate economic problem of the PTI government 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.

 

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 needed further borrowing of Rs 1.5-2 trillion and that is happening in CY 2019 as well.

 

What happens that additional amount brought through fiscal deficit enters in to the market and enhances its demand capacity 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 $ 6-12 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 US and 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 is also 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 inflate 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 121 per dollar to Rs 143 per dollar. Soon it would cross Rs 160 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 and more likely it would further increase in FY 2019.

 

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.

 

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 requiredi.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. In regard to 2019 tax amnesty scheme of PTI It should be remembered that Tax amnesties have better chance of success when tax body is already strong with its analytics, audit and other skills publicly displayed. Need one add that FBR’s user-friendliness and media/public perception have to be improved before the amnesty, and not simultaneously? On both these account, the proposed 2019 amnesty is nothing but jumping on the gun.
5. Simultaneously, there is a need to arrange external financing in the short term.
6. 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 manpower from Pakistan but for this strict follow up is required. This canraise the Remittance to at least $ 21 billion from current $ 18 billion.
7. 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.
8. For development expenditure it should be made mandatory that its 80% has to be used on education, health, clean water and keeping streets clean.
9. 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.

 

Table 1
Export Receipts by Commodity $ in millions				Imports by Commodity $ in millions
	2017	2018	2019 (up to Feb /March 2019)		2017	2018	2019(up to Feb /March 2019)
Foods Total (Prominent Rice)	3,711	4,797	2,100	Food group	5,417	5,501	2,050
Textile  (prominent Yarn, cloth, knitwear, bed wear, readymade garments)	12,451	13,521	6,500	Machinery	7,410	8,785	3,040
Petroleum products (Main solid fuel)	189	394	182	Transport	2,643	3,206	1,010
Manufacturing products	3,096	3,399	1,518	Petroleum group	10,607	13,263	5,200
others	974	1,100	1,387	Textile	3,589	4,091	1,902
Total Exports	20,422	23,212	11,687	Agriculture/Chemical	7,123	8,310	3,953
				Metal	3,673	4,781	1,700
				Rubber/wood/Jute/paper	1,196	1,255	490
				others	5,620	5,382	2,120
				Total Imports	48,683	56,002	21,465
Four Main Regions For Exports/Imports $ in millions
Regions	2017	2018	2019(up to Feb /March 2019)	Regions	2017	2018	2019(up to Feb /March 2019)
Exports				Imports
GCC	2,148	2,592	1,014	GCC	13,050	16,046	6,691
China/Japan/Korea	2363	2456	805	China/Japan/Korea	18,464	19,779	6,693
North America	3,923	4,132	1,802		2,538	2,438	1,088
Europe	7295	8133	3,648	Europe	6,303	7715	2,656
South Asia Malaysia/Indonesia/ Thailand/ Singapore	1,085	1,356	566	South Asia Malaysia/Indonesia/ Thailand/Singapore	5,519	6,677	2,586

 

 

 

 

Table 2 Important Data
	FY2017	FY 2018	FY 2019 (Feb/March 19)
Real GDP growth % market prices	5. 7	5.4	3.8
CPI (YOY)%	3.4	5.8	8.0
Tax revenue –FBR Rs in billions	4,937	5,228	2.327 (July –Dec 2018)
Policy Rate	6.0	8.50	10.75
SBP’s reserves (end-period) $ in billions	16.144	16.4	14.9
Worker remittances $ in billions	19.351	19.625	15.9
FDI in Pakistan $ in billions	2.0	2.1	1.2
Current account balance  $ in billions	-12.621	-18.130 ($ -11,421 Up to Feb 18)	$ – 8.84
Fiscal balance deficit %	– 5.8	– 6.6%	-8.0