HIGHER INFLATIONARY PRESSURE & RISING FISCAL DEFICIT

SYED KANWAR ABBAS
Feb 18 - 24, 2008

The simple economic theory offers the logical reason to manage monetary aggregates because the heavy doses of money supply will turn into accelerated inflationary pressures in the long run. Economists widely agree that the gradual change in the interest rate does not trigger much larger effects on the health of economy in the short run. However, interest rate is considered to be an important instrument of monetary policy to intervene in the major macroeconomic indicators of the economy. The rise in discount rate to 10.5 per cent in recently released Monetary Policy statement for second half of FY-08 has been observed as major threat to the growth of industrial sector. It is also arguable that the measures of central bank to reduce inflation would not work in the presence of higher prices of POL products and palm oil in the international markets.

The current trend of higher inflationary pressures can have negative effects on the path of growth momentum for Pakistan's economy. This requires curbing the growth of monetary aggregates which are targeted at 13.7 percent for FY-08. Therefore, the State Bank of Pakistan continues its tight monetary policy operations in the recently released Monetary Policy statement for second half of FY-08. The central bank also claims positive effects of such measures on economic activities; especially core inflation was reduced during FY-06 & FY-07. The SBP is also of the view that the further tightening of monetary policy is a right choice for the time being to achieve the GDP growth target of 7.2 per cent and achieve inflation target of 6.5 per cent (from the current level of 8.8 per cent (YoY) in Dec-07) in the remaining half of FY-08.

The State Bank of Pakistan also took a number of policy measures in its H1 Monetary Policy Statement (MPS) FY-08, which also included recommendations to the government to follow quarterly and annual ceilings on budget borrowings from SBP and used balance domestic debt strategy (i.e. using long term financing sources). The SBP advised the government to reduce its borrowing from SBP and diversify its borrowings sources in FY-08. The similar strategies have been used to control inflationary pressures in the H2 Monetary Policy Statement FY-08, which interalia includes the following remarkable measures as described below:

* The policy discount rate has been raised to 10.5 per cent from 10 per cent---an increase of 50 basis points.

* CRR has been raised by 100 basis points for deposits of one year maturity. It has been tried to initiate the mobilization of long term deposits.

* SBP has already introduced Long Term Financing Facility (LTFF) to promote the export-led environment in the country. Under this scheme, financing up to 10 years will be provided to the borrowers for purchasing input items both from local and foreign markets.

* Another positive move observed in the MPS is the compensation to the private and public sector enterprises that unfortunately bore losses with the tragic fact of the 27th Dec. 2007. The affected enterprises would be given incentive based packages to revive their economic activities in the short period.

The central bank blames that fiscal imbalances are creating complications for the successful operations of monetary policy. Government borrowings have crossed both quarterly and annual ceilings, which may lead to increase monetary growth and, thus also disturb other macroeconomic indicators. The central bank has already warned the government to diversify its borrowing sources as almost 60 percent of budget deficit has been financed from the commercial banks and central bank for the July1 to January 20, FY-08. However, government remained unable to meet its fiscal deficit and, as a result, central bank funded Rs237 billion to budgetary expenditures from July1 to Jan19 of FY-08 against only one third of this amount in last fiscal year (See Table 1). However, the measures of tight monetary policy have also showed reduction in the reserve money growth from Rs166.5 billion in July 1-Jan 19 FY-07 to Rs116.2 billion in July 1-January 19 FY-08.

THE RISING FISCAL DEFICIT

The aggregate demand pressures in the economy are putting constraints on the part of the government to maintain its fiscal deficit within the limits of Budget Estimates 2007-08. These demand pressures can be exploited with the exploration of new channels of revenue mobilization in the economy. A number of factors unknown at the time of budget-making have also led to increase fiscal deficit. Below are reported few factors, which became the cause of rising fiscal deficit during the first half of FY-08.

1. LOWER THAN EXPECTED TAX REVENUE COLLECTION

The net federal government revenue receipts have decreased from Rs.419.8 billion in July-Dec FY-07 to Rs391.5 billion in July-Dec FY-08. The major dint was observed in the collection of direct taxes from the level of Rs176.5 billion in July-Dec FY-07 to remain only at Rs163.9 billion in July-Dec FY-08. On the other hand, the non tax revenue also decreased from Rs173.5 billion in July-Dec FY-07 to Rs148.9 billion in July-Dec FY-08 (See Table # 2).

2. EXCESSIVE INCREASE IN GOVT. EXPENDITURES

The increase in federal government expenditures has not been off set by the increase in net federal receipts. Expenditures have grown excessively in comparison to increase in federal receipts. The total current expenditure has reached Rs588.2 billion in July-Dec FY-08 against Rs458.7 billion in the same corresponding period of last year. On the other hand, the development expenditures stood at Rs144.4 billion in July-Dec FY-08 while it was Rs93.8 billion in the same period of FY-07. This reveals that total expenditure stood at Rs732.6 billion in July-Dec FY-08 against the previous level of Rs552.5 billion in July-Dec FY-07 (See Table # 3).

3. INCREASE IN INTEREST PAYMENTS ON DOMESTIC DEBT

Another fiscal imbalance was observed with the rise in interest payments on domestic debt. The amount on servicing of domestic debt is Rs205.5 billion in July-Dec FY-08 against Rs131.2 billion for the corresponding period in the last year. The Budget Estimates 2007-08 shows Rs318.2 billion for servicing of domestic debt. However, if this trend continues, the servicing of domestic debt would roughly be doubled crossing Rs400 billion against the budget estimates of Rs318.2 billion at the end of FY-08.

4. FALL IN NET EXTERNAL INFLOWS

The net external financing was estimated at Rs193.1 billion in budget estimates 2007-08. In this context, the monthly average of net external inflows should be roughly Rs16 billion. However, the total net external financing is estimated at Rs61 billion instead of around Rs80 billion during July-Nov FY-08. This shows decrease of almost Rs20 billion against the prescribed budget targets.

5. SUBSIDIES ON PETROLEUM PRODUCTS

Govt. is adopting the soft corner polices for its masses and has not yet shifted over the effects of higher international oil prices hovering almost at $100 per barrel in the international market. These provisions of higher subsides on petroleum products has disturbed the government budgetary targets of FY-08. There was no idea of such an exorbitant hike in the international oil prices at the time of budget making.

6. PRIVATIZATION PROCEEDS

The budget estimates 2007-08 mention that an amount of Rs75 billion would come as privatization proceeds in FY-08. However, the amount of privatization proceeds has been delayed leading to increase the deficit.

TABLE 1

MONETARY AGGREGATE FLOWS (RS BILLION)

 

ACTUAL FY-07

(JULY 1-JAN 19) FY-07

(JULY 1-JAN 19) FY-07

Money Supply (M2)

658.3

199.8

234.4

Growth

19.30

5.87

5.77

Net Budgetary Support

102

46.7

234

From SBP

-58.6

70.9

237.1

From Scheduled Banks

161

-24.2

-3.1

Reserve Money

209.1

166.5

116.2

Growth

20.90

16.63

9.6

SOURCE: SBP


TABLE # 2

FEDERAL GOVT. REVENUE RECEIPTS (Rs in Mill)

 

2006-07

2007-08

 

BUDGET ESTIMATES

PROV. ACTUAL JULY-DEC.

AS %AGE OF BUDGET

BUDGET ESTIMATES

PROV. ACTUAL JULY-DEC.

AS %AGE OF BUDGET

Tax Revenue (a+b)

840923

416443

49.5%

1030547

430073

41.7%

a) Direct Taxes

271913

176567

64.9%

408250

163951

40.2%

b) Indirect Taxes

569010

239876

42.2%

622297

266122

42.8%

Non Tax Revenue

241887

173546

71.7%

337592

148948

44.1%

Gross Federal Receipts

1082810

589989

54.5%

1368139

579021

42.3%

Less Provincial Share

378260

170152

45.0%

465964

187447

40.2%

Net Federal Receipts

704550

419837

59.6%

902175

391574

43.4%

Source: MoF


Table # 3

FEDERAL GOVERNMENT EXPENDITURE (Rs in Mill)

 

BUDGET ESTIMATES 2006-07

PROV.
ACTUAL JULY-DEC. 2006-07

AS %AGE OF BUDGET

BUDGET ESTIMATES 2007-08

PROV.
ACTUAL JULY-DEC. 2007-08

AS %AGE OF BUDGET

Total Current Expenditure

879778

458708

52.1%

1056350

588230

55.7%

Development Expenditure

320000

93806

29.3%

393261

144387

36.7%

Total Expenditure

1199778

552514

46.1%

1449611

732617

50.5%

Source: MoF