BUDGET 2004-05: AN ANALYSIS

The micro-level should also be kept in view to assess the real state of economy

Report by Institute of Policy Studies
July 05 - 11, 2004

Economic Survey 2003-04, describes the state of national economy as improving. Macro-economic indicators are positive and denote economic stability. GDP growth rate has reached 6.4%, which is not only higher than the target of 5.3 per cent but also the highest in last eight years. This high rate of growth has been achieved mainly due to the extraordinary performance of industrial sector. Growth in the large scale manufacturing sector (LSM) was recorded at 17.1%. Services sector grew at the rate of 5.2%. Though the growth in agriculture, the most important sector of the country's economy, was 2.6%, near to 50% less than the targeted 4.2% percent, this was offset by extraordinary high growth of LSM sector.

It is being expected that at the end of fiscal year (2003-04), federal revenues will reach to Rs. 510 billion about 11 percent higher than the last year's 460 billion. The debt servicing has come down from nearly half of the revenues to 27%. This has provided the government with a fiscal space to increase its spending on poverty reduction. This spending has gone up to Rs. 239 billion, from Rs. 209 billion, an increase of 14%. Banks have provided Rs. 258 billion loans to the private sector during first 10 month of the fiscal year (July 03 to April 04), as against Rs. 168 billion. of the corresponding period, thus increasing by 84%. The investment has therefore, risen for 16.7% of the GDP to 18.1%.

Exports are rising at a rate of 13 per cent while the target was 8 per cent. Now the exports have reached $12.5 billion. On the other hand, imports have also increased at a rate of 19%, which is quite higher than the target of 5%. It has widened the trade deficit but this deficit is being termed as healthy, as it includes increase in imports of capital goods and industrial raw material by 30%, which is an sign of increasing industrial activities in the country. Overseas Pakistanis have sent remittances of $ 3.2 billion in the first 10 month of financial year, while the target for the year was $3.6 billion. Current account is positive for the third successive year and now the surplus is $1.6 billion. Forex reserves have reached to $12.5 billion and are assumed to be sufficient for one year import.

The budget deficit has been 3.9% of the GDP, slightly less than the target of 4%. Government claims that its economic policies and reforms of last four/five years have started impacting with trickle down effect and improving the lot of the product at the grass roots level. This is substantiated on the basis of results of a sample survey of 5046 households. According to this survey, poverty in the country has come down by 4.2 percent in 2004 as against 2000-01.

No doubt these figures are encouraging and should not be ignored in any analysis of the economy. But this is just one side of the picture. Along with these positive macro-economic indicators, the facts at the micro-level should also be kept in view to assess the real state of economy. The following facts need attention in this regard:

While the performance of the large scale manufacturing sector has been extraordinary and was the main reason behind higher economic growth, there are reports of many small and medium industrial units (SMEs) facing closure.

The country has seen macro-economic stability but poverty and unemployment have risen. The government has itself admitted that unemployment has increased from 7.82% in 2000 to 8.27% in 2004. The ratio is even more alarming in urban areas where it stands at 9.8%. The claim of 4.2% reduction in poverty is based on a sample survey of only 5046 households, conducted between April 19 to May 6, 2004. Independent experts and analysts, and the reports of World Bank and State Bank of Pakistan on poverty, do not agree to this claim. The results of this survey can not be termed as indicative of the real situation of poverty in the country. It is important to note that the earlier surveys conducted to measure the level of poverty had samples consisting of atleast three times higher number of households. Moreover, these surveys were based on the income of all the four quarters rather than one quarter of the year.

Overall GDP growth has increased but growth in agriculture, the most important sector of the national economy remained lower than the target: 2.6% against 4.2%. Two third of the country's population is associated with agriculture. How come the lower growth in agriculture would not have proportionally affected a larger segment of the population.

The allocation for debt servicing and interest has come down, but domestic loans have witnessed worrisome increase. According to the State Bank of Pakistan, the government obtained Rs. 67 billion domestic loans during July 2003 to March 2004, which is 4-1/2 times higher than the target for the year, i.e. Rs. 15 billion. In fact, the total burden of loans on national economy has increased to 4 trillion from 3 trillion during last five years.

IMF's Poverty Reduction and Growth Facility (PRGF) program has been successfully completed, but such arrangements with Asian Development Bank (ADB) and World Bank (WB) still continue. Therefore one should not overlook the fact that pressures and influence of international financial institutions (IFIs) still exist.

In government claims, the Foreign Direct Investment (FDI) will reach to $1 billion at the end of financial year. But this figure includes privatization proceeds as well. It is not correct to include privatization proceeds as FDI, because privatization does not represent any asset creation or real increase in economic activity. It is also incorrect to believe that environment is favourable for foreign direct investment in the country. International investors gauge the situation in a different way. United Nation Conference on Trade & Development (UNCTAD) has developed two indices regarding FDI. One is called the Performance Index and the other Potential Index. Pakistan stands at 116th position among the 140 listed countries in the first index and even lower at 129th in the second. It is evidently misleading therefore, to assume that the environment has really become favourable for foreign investment. The worsening law and order situation in the country is in itself a clear indicator of an unfriendly investment environment.

The budget 2004-05 is being termed as Pro-Growth, Investment-Oriented and Business-Friendly. No doubt that this budget offers many incentives that are quite attractive for business community, investors, industrialists and landlords. But the economy needs fundamental changes. And the question is weather the government is successful in bringing any sort of structural change in economy? Does the budget announcements and measures really address the challenges faced by national economy. Unfortunately, this is hardly reflected in budget making and formulation of the economic policy.

No doubt budget making is one the most difficult tasks. It is one of the basic principles of economics that needs and desires are unlimited while the resources are limited. Budget making is a practical exercise of this principle. This exercise is even more difficult for a government, which is answerable to the parliament and also faces a vocal press. The scarcity of resources and large number of demands do create a situation where every demand can not get the required attention. However, this is the challenge for the budget makers and they can also make it an opportunity. Following points are important in this regard:

Budget formulation and presentation hold a great significance towards the government's performance, particularly with regards to transparency and governance. Transparency factor helps in creating confidence about the government among various segments of the society and they can play their role for attaining desired national objectives. However, many basic changes made by the government while presenting the budget 2004-05 affect the general confidence. Base Year has been changed from 1981 to 2000-01. Changing of Base Year is not itself a wrong practice, but this change has been brought about after 23 years. Usually Base Year is changed after every 10 years around the world and then figures of both Base Years are given for comparison for at least two to three years. This has not been done in our case, which is creating difficulties in comparison and analysis. It is yet another dimension of establishing trust that how much time is available for debate and discussion on the budget. Seeing from this angle, the presentation of budget with just two and a half weeks left for commencement of new fiscal years is not in any way a healthy sign.

Moreover, various heads of expenditure have been changed altogether in budget documents. The transparency demands that allocations against both heads should be provided for proper comparison and analysis. It is itself a big question that how much the available statistics are reliable? There has been some improvement in the work of CSO, State Bank of Pakistan (SBP) and Federal Bureau of Statistics (FBS) but there is no system to counter-check the statistics through independent sources. Politically motivated efforts to make the statistics acceptable and impressive affect the confidence in the whole process.

The Government has very enthusiastically and whole-heartedly followed the strategies of international institutions. The need is to objectively analyze both the positive and negative effects of this policy. The most important question faced today is weather to continue the present approach or a change is also required with this continuity? If the change is needed then what should be the direction. Macro-economic stability is itself a positive approach. It should be pursued whether IMF asks to this or not. But the exclusive focus on Macro-economic stability negatively effects poverty, welfare and distributive justice. What should, therefore, be done to minimize these affects alongwith macro-economic stability? The turning point of 2004-05 presented a new opportunity in this regard which at present seems to be lost.

The third important point is to assess that whether "IMF Bye Bye" is just a slogan or a reality and a new policy direction. Does it mean not to take further loans from IMF? If it is a step towards economic sovereignty then it is important to ask if the debt burden is IMF exclusive? In fact IMF is just one player. The debt burden includes loans from other sources and institutions like the World Bank, Paris Club, Asian Development Bank, market loans and bonds. This becomes further important as dependence on debts has not ended despite "IMF Bye Bye" slogan. External resources for fiscal year 2004-05 are estimated at Rs. 156 billion, a little less than $ 3 billion. The question is what is being done to minimize dependence on other sources of debt?

WTO is another dimension that increases the importance of the present budget. A new phase of WTO regime, already in process since 1995, will start during the next fiscal year, i.e. from January 01, 2005. What steps have been taken to face the challenges and benefits from the opportunities in the new scenario? How much this budget is reflective of the need to enhance the quality of our products and services and reducing their cost of production to make them competitive in international markets? The government's announcements to reduce cost of production include reduction of duty on 450 items/raw materials. This is a positive step but the coercive enforcement of sales tax remains there. How can domestic industry and business flourish in this environment? It is also important to note that though the upper slabs of sales tax have been waved and a single slab of 15 per cent has been announced, multiple rates continue on a number of federal taxes.

Another question that has a political dimension as well, is whether we should continue to believe that the growth would trickle down and bring positive changes at the grass roots level or we should assess that how much this theory itself is effective? The theory has proven wrong the world over during the in last four/five decades. How can it give positive results in Pakistan if it has proven wrong around the world? How can the objective of people's welfare be achieved if there is no change at the grass roots level? Is the budget moving ahead towards a direction that can lead to real welfare of the people? Welfare does not mean mere financial aid to the people. It is a comprehensive concept. For example, welfare aspect demands that if agriculture holds one fourth share in GDP, two-third of the population is dependent on it and 60-70% of exports are directly or indirectly related to it then this sector should be included in the budget as a priority. Are the needed resources being provided for it? It is also important from the welfare point of view to reflect as to how much employment is generated through the glittering industrial sector? What is the capital employment ratio? The fact is that the capital employment ratio in large scale industry is Rs. 4 million to one while SMEs provide same amount of employment for only Rs. 150,000. Has the budget moved forward towards any new policy for SMEs and incentives they really need?

The most important element is basic structure of the budget. One way of looking at the basic structure of the budget is to compare its basic elements like volume, current expenditure, development expenditure and revenues with the previous year. Seeing in this way, one finds that total volume of the budget 2004-05 is Rs. 902. 7 billion, as against Rs. 868.3 billion revised estimates for the year 2003-04. Total receipts are Rs. 796.3 billion as against Rs. 760.9 billion, tax revenues are targeted at Rs. 580 billion as against Rs. 510 billion, current expenditure is Rs. 714 billion as against Rs. 700 billion, while development expenditure is Rs. 202 billion as against Rs. 154.3 billion. Apparently, there seems a significant rise in these basic elements, particularly in tax revenues and development expenditure. But the following situation emerges when these elements are seen in the context of GDP.

Total receipts of fiscal year 2003-04 were 18.5% of GDP. These will be 17.4% in the next fiscal year. This in a way indicates a decline in revenue generation.

Direct taxes are 3% of GDP in both years, and there is no increase or improvement. Similarly indirect taxes are frozen at 6.4% of GDP.

Current expenditure in fiscal year 2003-04 was 14.3% of GDP, which will now go down to 12.2%. But the main element behind this decrease is reduction in debt servicing.

Looking at the basic structure one may note the fact that the share of debt in resources is almost at uniform level. In both the years, borrowed resources make up one third of total resources.

The above-mentioned points make it quite evident that there is no qualitative change in to basic structure of the budget.

Growth is made possible through investment. Government has set a target of 8% GDP growth for up to 2006-07, while it is 6.4% in 2003-04. For this, the investment rate is targeted at 20 per cent of GDP. Achieving a high rate of growth i.e. 8% is not possible with 20% investment target. This will become even harder in a situation where reports of international institutions like UNCTAD do not term the environment suitable for foreign direct investment. For 8% rate of growth, an investment of at least 24% of GDP is needed.

Human development is the most important area and the ultimate objective of all economic exercise. It is therefore but natural to take it a yardstick to assess the budget. The amount allocated for education in federal budget 2004-05 has been increased to Rs. 12.2 billion as against Rs. 9.6 billion in 2003-04. Similarly the allocation for health has gone up to Rs. 3.2 billion from Rs. 2.8 billion. This is an improvement, but as the percentage of GDP the amount for education in the year 2003-04 was 1.63%, which has now reached to only 1.7%. The allocation for health is even lower and comes to only 0.6 % of the GDP. These allocations are much higher in other countries and even South Asian countries are well ahead of us in this regard. Sri Lanka spends 3.2% of its GDP on education and 1.8% on health, India 4.2% on education and 0.9% on health, while Bangladesh spends 2.5% and 1.5% of GDP on education and health respectively. These figures show that in two most important fields of human development, we are far behind even from the regional standards, let alone international.

Another area of concern with regard to human development in Pakistan is agriculture. The budget has an apparently attractive package (announced by President Pervez Musharraf on June 10) for the agriculture sector. But how much benefit would really access to the agriculture sector from this package can be assessed from the following points:

Reduction has been announced in the price of imported DAP fertilizer by Rs. 100. In fact, only withholding tax on this fertilizer has been reduced from 6 to 1%, while the duty has been decreased from 30 to 10%. Based on these measures it is calculated that the price will come down by Rs. 100. The question is why and how the importer (who is not farmer but trader and investor) will pass the benefit on to the farmers? It is also important to note that why only this particular type of fertilizer was selected for reduction and other fertilizers and pesticides were exempted?

Interest rate of Zarai Taraqiyati Bank Limited (ZTBL) has been reduced from 14 to 9%. The budget document gives the figure of 11 to 9%. The point to ponder is that when interest rates on corporate and industrial loans have come down to 4-6%, who would have taken these expensive agriculture credits. It is in this background that agriculture credit has come down by 19 percent in just one year. Moreover, it is a well known fact that most of the agriculture credits are taken for non-agriculture uses and in many cases those influentials taking loans have no intention to pay back. Reduction in these loans and restrictions on ZTBL to take punitive action will mainly benefit these corrupt elements.

It has also been announced that the waiver in loans would benefit 2,50,000 farmers affected by drought. Following points are significant in this regard. For those having loans upto Rs. 5,00,000, the waiver is not on the principal amount but on interest, because it has been announced in the budget that they will have to pay either 50 percent of total or principal amount, whichever is higher. So it may be termed a misrepresentation of the facts by calling it a waiver on loans clarifying it. The waiver without of 75% on principal amount has been given to the defaulters of upto Rs. 2,00,000 in Balouchistan alone. There is no plausible reason for this discrimination. If the reason is the drought of yester years, it affected the whole country and more so the southeast of Punjab and Sindh. Also important in this regard is the fact that defaulters have got waiver, while law abiding and honest citizens who paid their installments in time did not get any benefit. Incentives should have been announced for them as well.

The biggest news for the agriculture sector is that an amount of Rs. 21 billion has been allocated for water development works. However, on detailed analysis on discovers that Rs. 17 billion will be spent on the ongoing projects like Gomal Canal, Thal canal, Raini Canal, Katchi Canal, Mirani Dam, Subukzai Dam, Satara cam and increasing the height of Mangla Dam. These projects will be completed by 2006-07. A small or project of Subukzai Dams will be completed in December 2005. The new projects will be joint of Rs. 3.28 billion. These details in our budget documents, make it clear that no revolutionary chang could be expected in the agriculture sector during the coming financial year.

The amount allocated for agriculture (other than water) is Rs. 7.29 billion. The situation is also not different here from that discussed in the case of water projects. Out of these 7.2 billion, Rs. 4 billion are allocated for the cementing of waterways. 1.8 billion are for the "ongoing" schemes, which are unapproved. The amount for approved ongoing schemes is Rs. 1.67 billion. Only Rs. 323 million, 4.4% are for the new schemes, which are planned or will be planned for the fiscal year under review. Even in these schemes, approved ones are of only Rs. 91 million. Moreover, out of the remaining Rs. 210 million, Rs. 100 million are intended for the import of bulldozers.

Reduction has been announced in import duty on tractors and other agriculture implements. Ordinary farmer does not import tractors and harvesting combines of 100 H.P or more. Tractors of less than 35 HP are used for specific purposes particularly in gardens and thus are not so relevant for the ordinary farmers.

Salaries of government employees have been increased by 15 percent. This is a welcome step but less than expected specially due to the rising inflation. Similarly pensions have also been increased. Pensions of those retiring before 1994 have been increased by 16 percent and those retiring after 1994 by 8 pre cent. This difference is also welcome but not enough. The fact in this regard is that those retiring before 1994 receive meager pensions, and the gap between the two groups will remain very wide despite 16% increase for the old employees. The increase should have been such so as to make the pensions leveled with the retirees of recent years.

The relief provided with regard to electricity tariff is also insignificant. For domestic users, 10 paisa per unit reduction means that a person consuming 100 units, whose bill is roughly Rs. 275, will get a relief of only 10 rupees. Electricity tariff increases significantly after 100 units so those consuming more will benefit even less. A reduction of 58 paisa per unit has been announced for commercial/industrial consumers. Two dimensions of this are important. First, it was reported soon after the budget that this reduction is only for four hours. The government has not denied this news so far. Secondly, there is no indication that this would give any relief to the consumers in the form of reduction of prices if businessmen and industrialists benefit from it.

The same survey regarding poverty has been discussed earlier. According to Planning Commission itself, a large segment, over forty percent of the population, lives just over or below the poverty line. These are called "Transitory Poor" and "Transitory Vulnerable". The former is 20.1 per cent, while the later is 20.4 per cent. A smaller change in financial position of these segments significantly affects poverty statistics. The planners and policy makers should not be mislead by such changes as in real terms this does not reflect any change on the ground.

The real affects of Capital Value Tax imposed on the sale and purchase of shares in stock market were not properly analyzed. It is, however, satisfactory that to Finance Minister has accepted the suggestions of Stock Exchanges and made amendments in this regard on June 22.

Based on the above analysis, we are constrained to say that the Federal Budget 2004-05 is by and large a continuation of the past tradition. It includes no steps that can be termed as setting a new direction for the national economy. Like in the past, which also includes 4/5 year's experience of the present Finance Minister, change of figures has been considered enough. No fundamental or structural change has been brought forward in the budget. Nor there seems any serious effort to transfer the benefits of economic reforms, stability and higher growth to the deprived segments of the society. To conclude, the budget has very little to rejuvenate the national economy.