ASAD FARID KHWAJA, Economist (asad.farid@akdsecurities.net)
June 22 - 28, 2009

Given the fiscal drain created by the war in the country's northern region and entrenched recessionary inclinations of the domestic economy, the FY10 budget with record fiscal outlays of PkR2.89tn - of which 17.6% (PkR510bn) will be financed through external inflows - has been termed by the GoP as a "Budget for a War Economy". This takes the size of the public sector expenditures to 19.3% of the GDP which clearly presage that, like the prevailing global trend - where governments in both developed and emerging economies have radically increased fiscal expenditures to kick start their slowing economies - the real growth driver in Pakistan will also be the public sector over the next two to three years.

Considering that the budgetary financing will to a great extent be through external loans and grants, private sector investment should be limited in our view. In addition, total development expenditure commitments of PkR725bn should address the acute requirement to buildup energy and water infrastructure on a fast-track basis in order to achieve sustainable economic growth. Furthermore, considering that the construction sector has high backward linkages, increased fiscal outlays, especially those to finance infrastructure development, should have a greater multiplier effect. In our view, real GDP growth will likely be in excess of 3.3% targeted by the GoP for FY10. In addition, greater focus on industrial and agricultural sectors - cumulative weight of 46.2% in GDP - should also be positive steps. Services sector is highly dependent on these two sectors.

At the same time, we think that the revenue targets set for FY10 are certainly ambitious considering that the prevailing economic slump will likely to take time to reverse. This view can further be supported by the fact that apart from few cosmetic new taxes on the real estate and on the salaried class, no serious attempt has been made in this budget to address the prevailing regressive tax regime and a shallow resource base. Can the tax target of 1.51tn (up 28.1%YoY) and non-tax target of PkR513bn (down 9.3%YoY) be met in this situation? There is need to review the likely budgetary gap in FY10 and potential financing options available to the GoP. Budgetary implications for the monetary policy and progression of the overall interest rate environment over the next 12 months are also important developments to be analyzed.

Revenues: Budgetary target PkR2.174tn - our estimate PkR1.917bn:

In FY10 total tax collection should stand at PkR1.43tn which will be marginally lower than the budget target of PkR1.51tn (9.6% of GDP).

At the same time, the elimination of PDL - where PDL collection contributed 21.3% to non tax revenues in FY09 - can negatively impact non-tax revenues in the next fiscal year.

In FY10, the GoP expects non-tax revenue to drop by PkR90bn to PkR513bn. However, in our view the reduction will likely be greater than the budgeted amount considering that the GoP anticipates "dividend" receipts from its investments in commercial enterprises to increase to PkR75.2bn (up 15.9%YoY) and SBP profits to remain stagnant at PkR150bn. This seems somewhat optimistic in the backdrop of likely slowdown in corporate profitability growth and expected sharp monetary easing in FY10.

In light of our projections for corporate profitability of publicly listed companies, fiscal "dividend" receipts will most likely be to the tune of about PkR70bn. In addition, considering that SBP profits are heavily dependent on domestic interest rates as evident in the graph - and profits from publicly listed commercial banks i.e. NBP, HBL, ABL etc. and via SBP holdings, we estimate SBP profits to shrink by about PkR20bn to PkR130bn in FY10 based on our projections for profitability of these banks and expectations for the cut in policy discount rate. This would translate into total non-tax revenues of about PkR487.7bn in contrast to the budgeted level of PkR513bn.


Gross revenue receipts will be close to PkR1.917tn as compared to the target of PkR2.17tn. With budgeted expenditures of PkR2.94tn, the fiscal gap will end up at PkR979bn i.e. 6.4% of the GDP. Nevertheless, with realistic cuts in development expenditures to PkR600bn - the GoP might be able to reduce the fiscal gap to 5.2% of the GDP (PkR780bn) as compared to the budget target of 4.9% (PkR722bn). In addition considering that the GoP has left a buffer of around PkR60bn in total subsidy outlays (total PkR132bn) for FY10, we think that fiscal deficit can further be reduced by 0.4% to 4.8% of the GDP.


To finance the budgeted fiscal gap of PkR722bn and total funding requirement of PkR1110.8bn (after removing the provincial share of PkR655.2bn from tax revenues), the GoP expects to raise PkR190bn through capital receipts (permanent & floating debt plus national saving schemes), PkR510bn through external loan and grants, PkR19.35bn through privatization proceeds, and PkR144.6bn through bank borrowing. Considering that bank borrowing is a balancing item in the budget, it is likely to increase if fiscal expenditure/revenue targets are missed or other financing sources are lower than anticipated.

The GoP expects external financing inflows of PkR510bn (PkR145bn from Tokyo pledges) as compared to PkR367bn in FY09. Of this amount, external loans will contribute 87% and grants only 13% to total external fund mix, which would logically translate into greater debt servicing drain in the future. On the other hand, the GoP plans to issue Global bonds worth PkR41bn in FY10, which under the current domestic and international conditions may prove fruitless. In order to assess the likely level of financing gap in FY10 we remove the budgeted privatization proceeds and bond issuance and concurrently adjust upward the fiscal deficit by PkR58bn.

If bank borrowing is restricted at the budgeted amount then the remaining budgetary financing gap will be PkR262.9bn. This would require either further cuts in development expenditure or negotiation for debt rescheduling and higher external assistance than that budgeted for FY10.


If the GoP refrains itself from additional bank and non-bank borrowing in FY10 and tries to fill the financing gap through other measures, it should help ease pressure on liquidity position of the financial sector and at the same time encourage the Central Bank to continue on the path of monetary easing. Assuming GoP bank borrowing will be in line with the budgeted level of PkR144.6bn in FY10, we think that the Central Bank will have room to cut the policy discount rate by 400-450bps on cumulative basis by Dec' 09. This view can be supported by the historical positive correlation between domestic interest rates and annual public sector borrowing.

In addition, the GoP plans to raise only PkR6bn through issuance of treasury bills and bonds and PkR231.4bn (up 8.3%YoY) from National Saving Schemes in FY10. Given that borrowing through NSS will only experience marginal growth in FY10, deposition accretion over the next 12 months should continue. This should have positive implications for interbank lending rates where the likely decline in KIBOR should be greater than that expected in the policy discount rate. Increased development spending coupled with an anticipated speedup in monetary easing and freeing of credit flows should help assist economic recovery in FY10. Based on a layered approach, we expect real GDP growth of 3.7% in FY10 as compared to the GoP target of 3.3%.