Difficult macroeconomic environment for the budget

By Zafar-ul-Hassan Almas

The U.N. World Food Program has warned that according to its estimates nearly half of the country’s 160 million people are at risk of running short of food due to rising grain prices. The poverty impact of the surge in food prices could be high and could wipe out years of gains in poverty reduction in recent years. Another report Global Development Finance 2008 contains horrible projections about the current account deficit of around 7 to 8 percent in the next five years. The situation on the fiscal front could not be different because fiscal deficit is likely to remain well above 5 percent of GDP.

Another timely warning from experts of international repute for the Oil-importing countries like Pakistan which are already running substantial current account deficits amidst tightening of international credit supplies is that the short-term options for addressing the problem of widening twin deficit are limited, and long-term adjustment to a higher oil-import bill should be facilitated to the extent possible by prudent fiscal policies, incentives to increase energy efficiency, and measures to promote export competitiveness.

High grain, oilseed, and energy prices represent the greatest challenge for policy makers in many developing countries and Pakistan is no exception. The challenge is to protect the poor, while keeping fiscal positions manageable and preventing second-round inflationary spirals. At the time of presentation of the Federal Budget 2008-09, it would be unfair to expect too much from a just two months old government which inherited a backlog of problems.

Federal Budget 2008-09 is going to be presented in the most difficult circumstances in recent economic history. It is to be presented in a peculiar macroeconomic background where internal and external shocks of highest intensity are testing Pakistan economy’s resilience. The economy has limited capacity to sustain such shocks. True, Pakistan’s economy grew robustly at 5.8 percent in 2007-08 which implies major correction from last year’s growth of 6.8 percent and slippage from this year’s target of 7.2 percent. However, in the given circumstances like political turmoil emanating from fragile political economy and an unstable law and order situation, supply shocks, coupled with external factors like a worsening of international financial crisis, and an unprecedented spike in global food and energy prices, the growth is satisfactory and represents strength of economic fundamentals.

The next year’s (2008-09) target for economic growth at 5.5 percent reveals the official recognition of difficult macroeconomic environment in which the Federal Budget 2008-09 has to operate. The high double-digit food inflation of more than 15 percent during July-April 2007-08 is likely to be a major contributor in eroding the gains of poverty reduction and macroeconomic stability of the past five years. It is quite early to predict real kind of relationship between the incidence of high inflation and the performance of key macro indicators during the next fiscal year, but one thing is crystal clear that combination of factors like dramatic surge in food prices, unsustainably high twin deficit, exchange rate depreciation, political uncertainty, and poor governance would definitely outplay the objective of prudent fiscal management.

The legacy of major disruptions of extraordinary nature like domestic food and energy shortage and a plummeting exchange rate with extremely high inflation are likely to prevail in the next fiscal year. To cover the widening current account deficit, about $3.4 billion in foreign exchange reserves have been drawn down since July 2007, bringing the merchandise import cover below sustainable level of three months. Pakistan has added around $10 billion to its external debt stock in just two years. The fiscal deficit has also widened substantially and led to substantial borrowing from the SBP as foreign lending has largely halted, the privatisation program has stalled, and Pakistan’s spreads on international markets have risen. Surging food and fuel prices are contributing to rising inflationary pressures. Consumer price inflation was up 17.2 percent year over year in April 2008, from 14.1 percent in March; that is the fastest pace in at least 25 years.

The Federal Budget 2008-09 has to inherit large slippages of the outgoing fiscal year which have occurred on the expenditure side mainly on account of subsidies on oil, power, fertiliser, wheat and other foods. Now the government has to decide whether these are to go in one go or stay for some more time. The current level of oil subsidy at Rs.175 billion is simply a disaster and it may continue to next fiscal barring some real measures are taken. Another legacy is the interest payments which has now a tradition of significantly surpassing their targeted level since 2006-07. Interest payments are to be around 50 percent of our tax revenues which is the highest ever level in Pakistan’s history. The gap is likely to be widened further because the payment of Eurobond 2009 is due this year and we have to make payment on this count. This would put additional strain on the debt servicing portion of the next coming budget.

Oil prices continued to rise at a greater pace during FY 07 and FY 08. An increase of over 116 percent has taken its toll during the fiscal year. The lack of action on the part of the government has exacerbated the fiscal situation in the first three quarters of the FY 08 as the high international price of oil were not passed on to the domestic consumers. Consequently, the oil subsidy is projected to rise at Rs.175 billion which is quite high by all standards. Rising food prices have added salt to the wound and created demand for huge quantum of subsidies.

Furthermore, the tax revenue collected by the Federal Board of Revenue (FBR) fell short of the target and this was more than compensated by the additional revenue mobilisation through non-tax revenue. However, the pace of increase in the current expenditure was far too ahead. The tax-to-GDP ration is falling persistently and unabatedly for some years. The adverse developments on the revenue and expenditure sides are likely to result in massive slippages in the overall fiscal deficit for the year 2007-08. Against the target of 4 percent of GDP for the year, the actual fiscal deficit will be around 6.5 percent of GDP — the highest in the last ten years. These massive gaps between budgeted and estimated revisions in current expenditure, the government made efforts to mobilise more resources on the one hand, and postpone development spending on the other. An adjustment of Rs 100 billion was made in development expenditure.

This is the backdrop in which Federal Budget 2008-09 is going to be presented and it is really Herculean task to make both ends meet. The macroeconomic situation is full of grey areas and fiscal imbalances are to aggravate the situation. It is very difficult to avoid temptation for fiscal profligacy in popularly elected governments because the genuine political parties have to reveal their political agenda through budgets. It is unfortunate that this budget inherited worst kind of macroeconomic launching pad from legacy of the past. The unfortunate part of this episode is that the government seemed very reluctant in taking critical decisions or realising the gravity of the situation.

The Federal Budget 2008-09 has to incorporate tough decisions but at the same time it should take care of more than 80 million people struggling to remain at some distance from poverty line. The Finance Minister, Prime Minister and the political leadership has promised relief for the poor but the purse of the political leadership is not backed by strong economic fundamentals. It is really acid test of the abilities of the economic managers and political leadership.