Fiscal
management in Pakistan
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The financing of budget
deficit has remained a fiscal dilemma for the various governments in Pakistan
By Dr. M. Hanif Akhtar,
Department of Economics, B.Z, University, Multan
Jul 03 - 09, 2000
The macroeconomic discipline is considered to have a positive impact on
the business climate in an economy. One of the indicators of such discipline is the fiscal
deficit. Fiscal record of Pakistan has not been impressive over the last two decades of
development. Larger budget deficits have persisted since 1970s, manifesting a lack of
proper management of the economy. Persisting fiscal imbalances have undermined the
performance of real sectors of the economy, increasing strain on the balance of payments
and unleashing inflationary pressures as well. The deterioration in budgetary disciplines
has also made the economy dependent on large-scale borrowings resulting in ever-increasing
burden of debt servicing.
Despite the fact that repeated efforts have been made by the government
to clear up the fiscal mess in Pakistan yet there seems to be no signs of success. Heavy
defense outlays, over-generous non-development expenditures, large payments on account of
debt-servicing and lower incidence of taxation have dominated the scene of fiscal
management. Given the fact that the economy has a potential to generate additional
revenues for the government, this potential has not been utilized fully. For instance,
agriculture sector, a major contributor to GDP (25% in 1998), is exempt from tax in
addition to tax evasion by the professionals, businessmen and non-salaried persons. Tax
structure of the economy is narrow-based, less elastic and depends more on indirect rather
than direct taxes. According to the State Bank of Pakistanís (SBP) annual report 1998-99,
direct taxes form 35% of total tax revenue and comprise mainly of income and corporate
taxes, while the indirect taxes comprising of sales tax, custom and excise duties etc.
form a major portion (65%) of the tax revenues. Factors like dependence on few taxes and
lack of elasticity in the tax structure has resulted in poor resource mobilization. Time
and again the country has resorted to deficit financing or borrowings from various
channels to bridge the fiscal deficit. A summary of public finance in Pakistan is provided
in table below.
Summary of Public Finance in Pakistan |
(% of GDP) |
. |
1980 |
1990 |
1994 |
1999 |
Total expenditure |
23.0 |
25.7 |
24.5 |
20.3 |
Current |
15.0 |
19.3 |
19.8 |
17.5 |
Development |
8.0 |
6.5 |
4.6 |
3.0 |
Total revenue |
16.2 |
18.6 |
17.3 |
16.9 |
Tax revenue |
13.7 |
14.0 |
13.3 |
13.4 |
Non-tax revenue |
2.5 |
4.6 |
4.0 |
3.6 |
Fiscal balance |
-6.2 |
-6.5 |
-5.9 |
-3.4 |
Financing the deficit
through: (% of deficit) |
. |
. |
. |
. |
I. External sources |
47.4 |
40.9 |
26.7 |
56.6 |
II. Domestic non-bank
sources |
9.6 |
52.8 |
59.7 |
105.4 |
III. Domestic bank
sources/ Deficit financing |
43.0 |
6.3 |
13.6 |
-62.0 |
Source: 1- GoP, Economic
Survey, Various Issues. 2- SBP, Annual Report 1998-99. |
During the first
two decades of development, fiscal performance remained exceptionally good as in most of
the years fiscal balance was in surplus. Even the years with fiscal deficits witnessed
only negligible amount of deficit (less than 1 percent of GDP). The government tried to
maintain fiscal balance by increasing the tax rates (mainly of indirect taxes) on various
commodities in the early sixties. Indirect taxes formed a share of 70.3% of total tax
revenue in 1961 and 75.6% in 1968.
With the increasing trend of public sector investment during the
seventies and the nationalization of industry and finance in 1972, the role of public
sector became significantly larger by middle of the decade. There was a substantial
increase in public expenditures from 3.0% of GDP in 1970 to 24.5% of the same in 1976
while revenues increased from 2.6% to only 14.6% of GDP during the same period. This
resulted in a fiscal deficit of 9.9% of GDP in the year 1976. During the end of 1970s, an
attempt was made to reduce the fiscal deficit through expenditure cuts and revenue
generation. But the government failed to control the deficit, being 9.2% of GDP in 1979,
mainly on account of increases in the level of subsidies. Because of greater availability
of foreign loans on concessional terms, most part of the deficit was financed through such
borrowings. A short-term stabilization program, supported by the IMF, was also initiated
reducing the deficit to 5.2% of GDP in 1981. Flow of external funds at concessional rates
and the availability of domestic non-bank loans helped the economy to mitigate adverse
effects of fiscal deficits that could have been higher otherwise.
Heavy defence expenditures, inflationary pressures and debt crisis in
the early eighties increased budget deficit to 8.5% of GDP in 1988, forcing the government
to resort to domestic non-bank borrowings. As a result of this policy measure, domestic
interest payments increased from 0.9% of GDP in 1979 to 4.3% in 1989. This resulted in
crowding out of the private sector investment as interest rates mounted up and the scope
for credit to this sector became limited. Lack of revenue-generating efforts and continued
growth in recurrent expenditures deteriorated the fiscal performance significantly during
this period.
With the start of 1990s, need to contain the fiscal deficit resulted in
macro-economic adjustment and structural reforms in the economy. The government adopted a
long-term strategy for achieving much desired fiscal discipline through self-reliance
policy. Controlling non-productive expenditures, withdrawing subsidies, downsizing the
public sector through privatization of public enterprises, especially those running in
losses, and better debt management were the principal tools of this strategy. During the
recent years, the government has resorted to correction of fiscal imbalance via increased
taxation and higher prices of public utility services under the directions of
International Monetary Fund (IMF). However, such policies to minimize the deficit have
resulted in higher inflation rates in the economy, heightening the social tension as well.
The budget deficit still remaining high (6.2% of GDP on average for the period 1990-99),
repeatedly overshooting the budgetary targets and commitments made to the IMF. This has
also resulted in suspension of financial support from the IMF on various occasions. The
government is striving for the fiscal adjustment through policy choices of both
controlling the current expenditure and generating revenues through the mechanism of
broadening the tax base and improving the revenue collection.
An analysis of the table above reveals that the efforts towards
resource mobilisation do not seem to have materialised at all. This is reflected by the
fact that the total revenues, as a percent of GDP, have stagnated around 17% since the
last two decades. Part of the problem is directly related with the stagnation of tax
revenues remaining almost around 14% since 1980 and onward. The scenario of current and
development expenditures communicates a different story at the same time. The level of
development expenditures has declined while that of current or the non-development
expenditures has increased over time. The situation is converse to that expected. The
decrease in deficit to the level of 3.4% of GDP during the year 1999 cannot be considered
an achievement as compared to that 1980. An obvious factor in this regard is the decrease
in level of development expenditures from 8% to 3% during the same period. Such a strategy
of slashing the budget deficit might be considered as inconsistent with development
aspirations of the economy.
The financing of budget deficit has remained a fiscal dilemma for the
various governments in Pakistan. The eighties started with financing of the budget deficit
mainly through external borrowings and bank sources. As a result of this strategy, not
only external indebtedness increased, it also led to inflation in the economy (about 12.5%
during the years 1981 and 1982). Hence, the government resorted to non-bank borrowings as
a major source of financing the public deficit during the period 1983-90. The move was
justified on account of debt crisis in the eighties and to prevent inflation as well. As a
result of this policy-shift, inflation remained under control (6.0% on average) during the
period 1983-90. Lack of domestic resource mobilization and the shortage of foreign loans
forced the government to make a hesitant move for additional funds from the World Bank as
a part of the structural adjustment loan (SAL) linked with stringent conditions.
Resentment on part of the government has resulted in disruption of these funds, time and
again.
During the 1990s, the government introduced various financial reforms
through the market-based instruments of monetary management. Increase in reserve
requirements, privatisation of commercial banks, license to establish private commercial
banks, greater financial autonomy to the SBP, development of secondary markets in
government securities, increase in commercial lending rates, credit control and capital
market reforms etc. are the main features in this regard. Bank borrowings still appear as
an important source of financing the budget deficit. Such a mode of financing the deficit
not only affected the pace of monetary expansion but also accelerated the rate of
inflation (10.6%), higher than annual average (7.3%) of the eighties. The bank borrowings
soared up as a result of financial reforms and the government needs for retirement of the
non-bank debt.
Fiscal imbalances that have been persistent since the last two decades
still stand as a big challenge for policy makers in Pakistan. This has eroded
credit-worthiness of the economy at international level by undermining the public
finances. For obtaining more favourable growth, external and internal balances and lower
rates of inflation, there stands a need for reducing current expenditures of the
government and controlling wastage of resources on current and development outlays of the
economy. There is also a need to reform the tariff structure in a way that results in
minimum revenue losses and greater mobilization of resources to achieve macro-economic
stability. In context of the present economic situation both at the regional and domestic
levels, economic development of the country cannot be expected to be promising, at least
in the short run. There is a need to adopt radical structural reforms in addition to the
stabilization measures already in vogue, for the economic revival and stability.
The policy of financing the deficit through bank sources has led to
greater monetary expansion and higher rates of inflation whenever the monetary authorities
adhered to such a financing mode. This trend of financing the deficit needs to be changed
to constrain and reduce inflation in the economy while rate of growth of output needs to
be improved. The issue of containing the fiscal deficit is also important to the extent
that prospects for financing the budget deficit through external borrowings, as has been
in the past, are not promising. With the end of cold war and the loss of strategic
position of Pakistan, the aid phenomenon faces an unsettled future.
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