FEDERAL BUDGET 2003-04: AN ANALYSIS
An Institute of Policy Studies Task Force Report
By Irfan Shahzad
July 07 - 13 , 2003
The National Assembly has approved the Federal Budget 2003-04 in record short period of five days. Despite this, the significance of dialogue and debate on the budget still sustains. Though the budget is primarily a document based on economic strategy that a country adopts, yet it is essentially inter-linked with a country's overall political, internal security and defence situation. In this context, the present analysis prepared by the Institute of Policy Studies (IPS) consists of three parts. In the first part, those dimensions of the overall situation in the country are discussed which directly or indirectly affect economy or economic activities. The second part discusses government's economic strategy, Economic Survey presented by it and its performance.
BUDGET VIS-A-VIS OVERALL NATIONAL SCENARIO
The uniqueness of the federal budget for FY 2003-04 is that it is the first budget of 21st century that has been presented in the Parliament created as a result of political process after three years of military rule. However, the setting up of an apparent non-military arrangement could not alleviate the tense climate of political uncertainty, insecurity and instability. The main reason behind this is lack of consensus among government, its allies and opposition on the contentious issue of Legal Framework Order (LFO). As constitutional amendments proposed in LFO are disputed, an issue of legitimacy of all the steps that continue even after the restoration of the Parliament has cropped up. Another obtaining reality, that if ignored may create difficulties, is absence of any ideal relationship between the central government and some of provincial governments and between provincial and the district governments. Budget is a document that plays an important role in setting right the priorities at the national level. Therefore, it is a practice among traditional democracies that the participation and discussion of public representatives and different segments of society is ensured well before even budget preparation. In present budget's case, due to political unrest and lack of unanimity, no such dialogue could take place — a situation not at all laudable from economic point of view.
Tension continued all through the FY 2002-03 on country's eastern borders. India brought its troops on the border and Pakistan had to reciprocate for its security concerns. This step highly pressurized the economic resources. The effects can be seen in the revised estimates of FY 2002-03 particularly regarding defence expenditure. Initially, 146 billion rupees were allocated for this, which increased, to Rs 160.1 billion. It excludes transfer from the defence budget to the normal budget pensions of the defence personnel whose financial responsibility comes to around Rs. 20 billion. Though the tension has, to some extent dissolved after the withdrawal of Indian forces but a mix of other factors directly played upon Pakistan's economy. US attack on Iraq and its invasion under the doctrine of "pre-emptive strike"; threats to Iran, Syria and other countries, and; India's efforts to increase diplomatic pressure on Pakistan despite apparently positive posture for talks are some of the factors, which revitalize attention on defence and security. It is pertinent to note here that Indian defence budget has been raised by 31% this year and the process of rise is continuing for last many years.
Economic activity and development, particularly domestic and international investment, demand domestic stability and peaceful internal conditions. However, law and order situation in the country is not satisfactory for many years. The worsening situation can be gauged from the fact that there have been incidents of killings of police officials in Baluchistan and some 'target killings" in Karachi even during the days of debate on budget in the National Assembly. Attacks on petrol pumps in Karachi and blowing out of gas pipelines recently are worrisome. The situation is too bad particularly in Karachi, which is the economic hub of the country. US magazine TIME in its recent issue [June 16] has declared Karachi as "Asia's Roughest and Toughest" city. Although this portrayal by TIME is more than exaggerated but such events and analysis affect the economic activity and the environment does not remain conducive for development. It is therefore necessary to keep an eye on these factors and improve them.
According to Economic Survey for FY 2002-03, some of the economic indicators are very positive. These include the following:
Overall GDP is expected to increase by 5.1% which is not only more than the targeted 4.5% but also highest in South Asia.
Agriculture, manufacturing and services sectors show significant improvement. Inflation remained 3.3%. Per capita GDP has increased to 492 dollars from 417 dollars, which is claimed to be a 17.4% rise. Fiscal deficit has decreased to 4.6% of GDP. Foreign exchange reserves are more than 10.5 billion dollars. There has also been a record increase in the remittances of overseas Pakistanis and they are expected to cross 4 billion dollars mark by the end of the year. Pakistani rupee has appreciated by 11% against dollar and current account now has a surplus of 3 billion dollars. Without going into debate that to what extent these positive trends are a result of government policy or other factors, the situation provides a new opportunity and it is useful to examine in this budget analysis how this opportunity is being utilized.
Despite having some positive developments, the traditional weaknesses of the economy are not only persisting but the situation deteriorated in some cases. Investment ratio is 15.5%, which is much lower than 18.7 average of the middle eighties. Social indicators are worrisome. Though most of the experts differ with the government estimates regarding poverty, it's own statistics show that 31.8% of population lives below poverty line. This comes to 47 million. Inequalities in income distribution are obvious. Available figures show that the share of top 20% in GDP has increased instead of decreasing, while the share of lowest 20% has further decreased.
Though no major scandals of corruption at the highest level have surfaced in this period but corruption at the lower level of government machinery is persisting. While, no scientific figures are available in this regard, the common view is that it has increased. The reason that it is not being so much discussed is that it now stands as an accepted norm. Where there is no direct corruption, inefficiency, nepotism and instances of disregard for merit are rampant. So, while at one hand government loses huge amounts because of corruption due to inefficiency in the system, most of the available resources are wasted. Same is the case with smuggling. The government made a number of announcements some two years back to eradicate the smuggling, but there is complete silence after those announcements. In order to sustain and improve the economic activity, a clear strategy is required to improve governance in the country.
The challenges posed by the Globalization and WTO and the opportunities offered by them are also very important in the present economic context. Only eighteen month are left in full implementation of the WTO regime that was formed in 1995. All the international trade would be conducted under the framework and rules and regulations of WTO from January 2005. We have to see that whether our trade and industry are capable enough to face the increased competition in changing scenario. If not, what policies and steps are needed in this regard?
Almost four years have passed since the Supreme Court's verdict on Islamization of economy while SC had initially given only 11/2 year. The question that needs answer is what the government has really done in this context? And whatever it could not do, what is it's planning and how is it reflected in the next year's budget?
ECONOMIC STRATEGY AND PERFORMANCE
To what extent the above scenario has been kept in mind while formulating the budget can be gauged from priorities announced by the Finance Minister. The Finance Minister has himself talked about many challenges in his budget speech, of which he regarded the following as most important:
1)Our GDP has to grow at an accelerated rate through investment in public and private sector. This would reduce poverty and create employment for the poor.
2)We have to further increase expenditures on education, health and human development.
3)Due to hemorrhaging in public sector enterprises, we cannot increase expenditures commensurate with our requirements. This has to be corrected so that more resources could be provided for human development.
4)There are still many areas in the country that lack roads, water, power, gas and other basic infrastructure. We need to do a lot in this regard and would require additional fiscal space for this purpose.
5)We have to further increase investment level. Our businessmen and industrialists have played a prominent role in economic development. We have to focus on these challenges and formulate second-generation reforms to move forward.
No one can dispute on most of the above-mentioned challenges. But the question is, keeping in view the present scenario and for the solution of permanent problems faced by the economy, do they reflect any new thinking and provide base for a multi-dimensional approach and activity? Do they lead in the right direction?
Actually it is not so. The points raised by the finance minister are an indication of continuing the strategy ongoing for many years aimed at macroeconomic stability. There have been some benefits of this strategy in the past and some may come in the future, but this is just one side of the picture. Many important problems like poverty, unemployment and inequality were neglected due to this strategy. It would be wrong to continue ignoring these in the future on the basis of some positive indicators in the economy. Also, it is itself important to examine the assumption and see that to what extent this improvement is a result of the economic policies of the present government. Following facts will have to be kept in mind to understand the reality.
* If the burden of overall debt has decreased, it is because of debt rescheduling by the Paris Club and one billion dollar write off by USA. This is not result of any sound economic policy but owes to the changing regional scenario and change in government policy on it.
* A major part of Forex reserves of 10.5 billion dollars consists of the remittances [expected to reach 4 billion dollars] of overseas Pakistanis. The main reason behind this surge in remittances is post-9/11 situation, in which overseas Pakistanis, particularly those living in USA and Europe are transferring their money to Pakistan considering it unsafe there. Also because of the global situation official channels have replaced the Hundi system for the transfer of money. There is no part of any sound policy in it as well.
* It is welcome that inflation is 3.3 % but main reason behind it is that purchasing power of the people has decreased. Moreover, despite this low level of inflation (according to the government figures), the prices of important household items including utilities like electricity, gas, petrol and food items like flour, ghee, tea and sugar have seen increase rather than decrease in the open market.
* The rise in GDP growth is mainly due to significant increase in agriculture production. It is also at least one reason behind turn around in the manufacturing sector. The improvement in the production of cash crops is because of good weather conditions and not any government policy. The increase in agriculture production, particularly in wheat is only an estimate. It is feared that wheat output may be 17.5 million tons, and not 19.5 million tons, which would affect the GDP growth estimate.
* It is true that the stock markets are bullish and KSE index has now crossed the 3100 mark but this trend is short lived. It is not rooted in increase in production, productivity or in number of productive units. Neither it has any relation to new listing in the market. It is rather a result of excess money in the market and appreciation of rupee against dollar. In fact there has been no worth mentioning new listing in the stock market. Therefore this temporary improvement cannot be termed as satisfactory.
* The claim that per capita income has risen to 492 dollars from 417 dollars is also misleading. Apparently it shows a 17% rise and looks eye catching but the fact is that we have only equaled the level we had reached in FY 1996-97 i.e. 492 dollars. Moreover, 17% rise is in dollar terms and has been arrived at not considering the depreciation of dollar against rupee. In rupee terms, the increase is 12% on the basis of current prices and only 6.3% on the basis of 1980-81 prices. Even this is not related with economic and productive activities but main reason behind this is also increase in income due to remittances.
It would also be pertinent to note here that no new and concrete initiatives have been taken to make sustainable use of this important factor (remittances). It is also important that amazing rise in remittances and more than 10 billion dollar of Forex reserves built as a result have not been used properly as yet. Thus heavy amount of remittances is being used either in sale and purchase of property or shares in the stock market. No productive use has been made possible. This also explains recent significant increase in property prices in most urban centers of the country.
There is too much liquidity available with the banks and as a result mark up rate has come down significantly. But the investors, particularly the industrialists are not borrowing money from the banks despite low level of mark up as money is available on even lower rates in the market due to rise in the remittances. The banks have started new schemes like car leasing and financing for the household items. A culture of excessive spending is taking roots in the wealthy segments of the society and also impacting negatively the lower level. It is inevitable to quickly formulate a strategy for productive use of these remittances on urgent basis.
An indication of over confidence owing to some positive indicators is that government is comparing its GDP growth with countries like Germany, Japan, Canada and USA. It is quite unnecessary and also misleading. Comparatively low level of growth does not make any big difference in the economic activity and livelihood of people in those countries because the level of development they have achieved and strong economic and social infrastructure they have built. Moreover, it is not right to expect them to attain a level of 8% growth after the high level of development they have already attained.
The government's insistence on continuing its 4-point strategy advocated for poverty reduction is also one of the reflections of its over confidence on its policies and the pressure of International financial Institutions. The strategy includes1) Macroeconomic stability and fast growth due to it, 2) investment in human resources, 3) government involvement in particular sectors 4) expansion in social security system and 5) good governance.
No doubt macroeconomic stability and fast growth may result in poverty reduction. But the experts opine that to achieve such a target it is necessary to sustain a growth rate of 7 or 8% for at least ten years and that too without any interruption. And to attain such a high growth rate it is inevitable to ensure increase in investment by 20% of GDP per annum. While presently, our investment rate is hardly 15-16% of the GDP and certainly it is linked with low level of savings in the country.
As to the foreign investment first, all experts do not consider it as one of the blessings. This is because there has been no capacity building in the country due to foreign investment. We have received the major portion of the foreign investment in the form of food and household items. One fourth of it is going to the oil exploration, which is not much helpful for increasing employment opportunities and overall economic activity. Moreover, it is rightly said that foreign companies transfer major part of the invested money out of the country in the form of profits. According to the State Bank of Pakistan, 69 multinational companies sent more than 320 million dollars out of the country in the form of profits during first none months of fiscal year 2002-03. Total number of the multinational companies in the country is 169 while total foreign direct investment in the same period stands at 658 million dollars.
Also regarding foreign investment, one must not forget that as their interest revolves around their own profit, they are never concerned to keep in view the needs of the country. This is the reason why we find only 16 of these 169 companies active in Punjab, NWFP and Baluchistan. Therefore, without having a prudent policy for foreign investment the country may not be gaining from it. Above all, it is necessary to improve judicial as well as law and order situation, not only for attracting foreign investment but also to activate domestic investor. Social and physical infrastructure should be improved. Better communication facilities and qualified and skilled labor should be made available. While there are some developments in the communications sector, there are no signs of overall improvement in this regard. To increase the growth and sustain it in the future, we will have to activate the industrial sector further. Presently its share in GDP is 18%, which is much lower than the 33% average of low-income countries.
As far as the expansion of social services for the common man is concerned, the so-called free health care facility that was available to the poor till recently has been practically abolished in this period. The standard of education in government institutions is going down. The rates of electricity have increased to a level where it has become a luxury for the poor. Privatization of such utility services has resulted in increased user charges making these facilities almost inaccessible to them.
Similarly, the claim of any positive development on the fronts of governance and financial discipline in any sector is hardly acceptable. As far as the human resource development is concerned, the allocations for education and health sector have been increased modestly. Such measures may bring some positive changes provided they do not become victim of corruption and wastage and are not donor driven only.
BUDGETARY TARGETS AND PROPOSALS
After analyzing overall economic scenario and government's strategy, the budgetary targets for year 2003-04 are being analyzed.
Expecting the growth rate of 5.1% in FY 2002-03, GDP growth target for the year 2003-04 has been set at 5.5%. This is achievable only when all the sectors of the economy, particularly agriculture, which contributes 24% to GDP, grow at the target rate. In year 2002-03 a growth of 4.2% has been recorded in the agriculture sector due to improvement in the weather condition. Agriculture also plays major part in the growth of industrial sector. Thus in order to ensure the target in the two sectors agriculture sector should have been given incentives to face uncertain weather conditions. No attention was, however, paid to this in the budget. There are fears that if the agriculture sector will not be able to grow at the desired level GDP growth target would be an uphill task.
The target for overall fiscal deficit has been fixed at 4% of GDP. Same was the target for year 2002-03. It was, however, raised to 4.6% in the revised estimates despite a 5.1% growth in GDP., i.e. from Rs 162.5 to Rs 181.3 billion. Would it be possible to keep it to 179 billion, less than the revised estimates for year 2002-03? Certainly it is a daunting task. It will become even harder to achieve if overall growth of GDP remains low.
The revenue collection target for year 2003-04 has been set at Rs. 510 billion, which is 12% more than the target 458 billion for the year 2002-03. Apparently the government has been encouraged with its last eleven months performance. In fiscal year 2002-03 (July-May) revenue collection has increased by 15%, but it must be kept in mind that CBR needs to collect Rs. 65 billion in June to meet the target for year 2002-03. It has never been possible in the history of Pakistan. So a short fall of a few billion rupees in the target of 458 billion by the end of current fiscal year (June 30) is not ruled out. It is feared that government may resort to increase the taxes on electricity, gas, and particularly petroleum to fill the shortfall. It will certainly affect the common man, which is already under heavy burden of taxes.
It is true that no new tax has been imposed in the budget, which should be appreciated, but necessary improvements in the tax collection that are long warranted were also not given attention. Taxes should be collected on the basis of "capacity to pay".
Presently, indirect taxes (including surcharges) are 83% of the total taxes. The target of 510 billion for the next year would also constitute 410 billion indirect taxes (and surcharges). This ratio is more than 80%, which cannot be termed as a healthy approach. On the other hand, though income tax is a direct tax but a major portion of it is also collected from low-income employees. It is important to note here that taxable income is presently 80,000, which also bring employees with Rs.6600 per month salaries into tax net. The expectations that this limit shall increase did not materialize.
An important aspect of the budget targets is that of the distribution of resources between Federation-Provinces that also affects their relationship. In this regard, the first serious problem arises because of the non re-constitution of the National Finance Commission (NFC). The share of the provinces from the consolidated fund is inequitable and much less than what the provinces need for their development and good governance. The criteria also deserves to be revised and should take into view, along with population, the specific demands of area and state of development, particularly the welfare and needs of the people. It is equity that is more important than simple games of numbers. While the developmental budget is claimed to have increased by 30% or 21.5% (14% as per our analysis) or whatever that is, the fact is that the share of the provinces in PSDP has increased only by 6.8%. This is also totally unfair. The allocation to Baluchistan in 2002-2003 budget was Rs. 17.483 billion which was reduced in the revised budget to Rs. 17.101 billion and the proposed budget for 2003-2004 as Rs. 17.140 billion which is actually less than what was budgeted in original 2002-2003 budget.
Finance Minister's assurance that no mini budgets will be presented is appreciable. But the past experience and present situation suggests that this assurance would be hard to fulfill. According to the press reports, the government has assured the IMF to raise power tariff by 6.6% during the next financial year. The news came very next day of the budget speech that the maximum rate of income tax on electricity bills has been increased from Rs. 700 to 2000. Similarly, fortnightly review of petroleum prices continues due to which the stability in prices cannot be guaranteed.
The development expenditure has been increased to Rs. 160 billion, which should be appreciated. In fact whatever increase is made in the development expenditure is positive but the claim that it has been increased by 21.5% is not true. It is much exaggerated. The fact is that development expenditure proposed in 2002-2003 was Rs. 134 billion (revised Rs. 131.6) and the one proposed for 2003-2004 is Rs. 160 billion, which represents only 19% rise. But then there is an operational shortfall of Rs. 8 billion in the budget 2003-04 which would certainly affect development expenditure. It means that the estimated developmental expenditure would only be Rs. 151.920 billion against Rs 134 billion of the last year and thus, it represents only 14% rise.
When the finance minister says that this is the last year to obtain loan from IMF, he indirectly admits that we have succumbed to the pressure of IMF regarding budget and other economic activities this year. In this scenario, the biggest challenge for Pakistan is that how to achieve self-reliance? How the dependence on foreign assistance and loans is reduced so that the influence of all foreign forces including IFIs in the decision-making is eliminated? Unfortunately, the budget documents do not reflect any intentions of changing debt-based strategy and the practice of getting loans from foreign and domestic sources continues like the past.
There has not been any significant improvement in debt servicing after rescheduling and partial debt write-off by the United States. Though it looks striking that debt servicing has come down from 64% of the revenues to 36% but total amount allocated for this purpose has not decreased. The revised estimates for year 2002-03 show a spending of 257.4 billion in this regard while 256 billion have been allocated for this purpose for the next year i.e. a decrease of only Rs. one billion. The amount spent on debt servicing is still 60% more than defense and development expenditures a clear indication of the harms of interest-based strategy.
Provinces are being charged interests on federal loans at the rate of 14 percent which is exploitative, unjust and totally out of line with the current rate of interest in the market or the rate of interest on which the federal government is making its borrowings. The interest rate on treasury bills is less than 2% and the market rate is between 4-9%. Then whatever debt rescheduling has been made in respect of loans and financial space acquitted thereby had not been shared with the provinces, which is highly objectionable. If the federal government is not prepared to be fair to its constituencies, how can national solidarity be achieved?
The amount allocated for defence has been increased. It has now gone up to Rs. 160 billion, which equals revised estimates for the ongoing fiscal year. This raise was inevitable in context of present regional scenario and security situation. However, the incidents of corruption in the defence deals that have been unveiled as a result of NAB's performance emphasize the need for stringent check and balance on the use of defence budget.
The benefits arising out of improvement in the macro-economic situation have not been transferred to common man and the budget has brought no steps needed to improve their condition and reduce their hardships. A 15% increase has been announced in the salaries and pensions of government employees, which is appreciable. It was needed. It is, however, less than the actual needs of employees, particularly of lower level. Moreover this raise is only for the government employees and no policy has been announced for the employees of non-governmental sector. Then there are reports that those retiring before 1990 would not get this rise. This is an anomaly and cannot be justified. The fact is that those retiring before 1990 are already getting lowest pensions due to lower rates of salaries in that period.
It has also been announced that government employees would be provided loans for building or purchasing houses. This step should be appreciated but plot prices are an important element in the development of housing sector. These prices are currently very high, and form the major part of total expenses. An important point is that except for the army, a large number of government employees live in Islamabad. CDA has not developed any new sector for many years. Where will the houses be built if there would be no plots? The excise duty on cement, wires and cable has been decreased for development of housing industry. The rate of excise duty on cement was Rs. 1000 per ton (20 bags) i.e. Rs. 50 per bag. Only a decrease of Rs. 12.5 would be possible with 25% decrease in the duty. As such the overall impact of reduction in duties of only two components would not really help in boosting the housing industry.
Major failure of the budget lies in neglecting agriculture, which contributes 24% to the GDP and supports over 60% of the population. The real issue was reducing the price of inputs for agriculture, and ensuring supply of good quality seeds. The demand of reducing GST on the prices of fertilizers and pesticides has also been ignored. Similarly, no comprehensive strategy has been initiated to provide cheap credit and development of delivery systems, marketing and storage mechanisms and export facilities. It is an example of the injustice to the agriculture sector that while interest rate in the market is 4-6%, ADBP is charging 14-16%.Reduction in the duty on paper is a good step in tax proposals. In fact, there is need to increase as much facilities as possible for enhancing educational and research activities.
No concrete policy was announced to address the issue of unemployment. According to the government statistics, 3.5 million people are unemployed in the work force of 39 million i.e. 8%. Unemployment is even higher in the cities and has reached the "socially disruptive" level of 10%. The Finance Minister has promised to provide employment to 2,00,000 people in the next fiscal year. Even if it is realized, it will not make a dent on the unemployment situation.
As far as the steps regarding Islamization of the economy are concerned, the permissions for Al-Meezan Bank to start commercial banking and setting up of Islamic Insurance Company are appreciable. This development, however, cannot be termed satisfactory. It is evident from the budget speech of the Finance Minister and budget documents that this subject is not included in the government's priorities.
The challenge that the country is facing from global competition due to liberalization of trade and impending WTO regime from 2005, has been totally ignored in the budget. The only way to face this challenge is to enable the industry and agriculture to face international competition. This needs a big package of incentives and public sector support programs to strengthen physical and social infrastructure, which is not in a position to cope with developmental needs. Cost of industrial and agricultural inputs has to be reduced to make our agriculture and industrial products competitive. Budget is interested only in raising revenues and not in promoting production, ensuring high quality of products and their standardization and arrangements for aggressive export promotion at the global level. The budget reveals no perception of this challenge and fails to prepare the country to face it.