Budget Stands on Weak Legs
Rosy expectations in the numbers may generate economic headwinds in the medium-term.
Let me start with a broad point: the 2021-22 budget is likely to further build economic momentum, creating optimism about Pakistan’s economic trajectory in the near-term. This optimism is likely to bolster the ruling party’s popularity, especially among Pakistan’s elite, generating momentum for Khan as he looks ahead to the 2023 elections.
Having said that, it is important to critically evaluate some of the assumptions and projections made in the budget, especially as they relate to Pakistan’s political economy.
On face value, the budget is likely to generate a spurt of growth while also exacerbating the structural challenges faced by the country’s economy.
Three broad numbers from the budget have led me to this conclusion:
The overall tax collection target;
Development spending (PSDP); and
Assumptions made about the current account balance.
The budget estimates that tax revenue receipts will increase by ~25 percent, going from Rs. 4.69 trillion in 2020-21 to Rs. 5.83 trillion in 2021-22. Here it is important to recall that the government has missed its revenue collection target in previous budgets, even after downward revisions were made to the target. For example, the original tax revenue target for the 2020-21 budget was Rs. 5.46 trillion, which was revised downwards to Rs. 4.96 trillion, a decrease of ~9 percent.
Sales tax collections are budgeted to increase by 30 percent, going from Rs. 1.93 trillion to Rs. 2.51 trillion. This expectation rests on the government’s ability to broaden the tax net by getting retailers and wholesalers to pay their fair share of taxes, something that successive governments, including General Musharraf’s, have been unable to achieve.
The budget also expects that the government will collect an additional 22 percent from the petroleum levy, which is budgeted at Rs. 610 billion. In recent months, the government has actually reduced its share of the levy in order to not pass the burden of rising oil prices to consumers, and with oil prices inching upwards, it is a big question mark as to how the government will meet this target without raising petroleum prices, especially since it continues to face criticism for persistently high inflation rates.
With elections around the corner, it is highly unlikely that the government will aggressively go after non-compliant traders, who are an influential vote bank across the country. Additionally, it is unlikely that the government will increase petroleum prices and collect higher levies, especially given the persistently high rates of inflation.
Meaning that at some level, the government may not spend as much as it is targeting to in the coming months.
Development Spending (PSDP)
This is where the PSDP budget comes in, since not spending the budgeted amount for development spending is the easiest way to account for lower-than-expected revenue collections. The budget has targeted Rs. 900 billion for Federal PSDP, an increase of ~43 percent compared to the Rs. 630 billion spent in 2020-21.
There are questions about both the government’s capacity to spend an additional 40+ percent in the 2021-22 fiscal year, as well as the state’s ability to mobilize the additional sums of money to fund this spending (outside of running a higher fiscal deficit). Which means that I expect the government to reduce this spend, especially as the revenue targets are revised downwards in the coming months.
What this essentially means is that the expected multiplier effect of government spending through the PSDP is not going to be as high as what the budget indicates, something that is important to keep in mind as government spending plays a key role in generating economic growth in Pakistan, especially in a high inflation environment where household purchasing power has and continues to be eroded.
Current Account Balance
Yes, we all know how terrible current account deficits are (or are they really that bad?) ever since the PTI government came to power. And yes, it is important to keep an eye on this statistic because a broadening deficit almost always indicates that the punch bowl is about to be taken away and another round of austerity and macroeconomic stabilization is upon us.
The budget document recognizes the importance of this figure:
For sustained economic growth in medium term it is imperative for the Federal government to accordingly pursue a multipronged strategy with focus on revenue mobilization, rationalization of recurrent expenditures to provide space for development/ capital expenditure, support for the driver sectors of the country’s economy and increase the foreign exchange earnings for management of current account and easing off pressure on the Rupee (PKR).
This budget is going to lead to higher rates of growth, which will inevitably create pressures on Pakistan’s current account balance. To ensure that this balance remains manageable, the government is banking on higher remittance flows and export earnings.
But as growth picks up, imports are likely to blow past expectations, and the resumption of normal economic activity around the world, including travel, could shift some formal remittance flows back towards informal channels. Additionally, higher oil and commodity prices in international markets could further increase Pakistan’s import bill, creating a current account balance that is wider than the $2.5 billion deficit currently being projected.
Rosy assumptions have made folks optimistic about Pakistan’s economic growth in the coming fiscal year. And as I mentioned at the top of this post, growth is definitely going to increase in the coming months.
But two questions remain:
Will the IMF play ball with the government and continue to give its blessing to a strategy that continues to ignore the program’s conditions?
Can this momentum be sustained, especially as both fiscal and current account deficit projections are not met?
We should have the answer to the first question in the coming days and months (I bet you that the IMF is not happy about the 226 percent increase in subsidies; 87 percent of the Rs. 682 billion are for the power sector). However, this won’t just be an economic conversation between the IMF and Pakistan, and my guess is that a lot will depend on broader geopolitical issues, especially as it relates to ongoing conversations between the U.S. and Pakistan.
As growth picks up, we will start seeing more data as it relates to the second question. Having lived through recurring economic crises since the Musharraf-era, I have to say that I am not terribly optimistic, especially since the difficult decisions that must be made to reform Pakistan’s elite-captured, rent-seeking economy cannot be made by a government that is already planning for the 2023 elections.