New budget, macro-economic

instability, poverty, wheat and energy crisis

By Dr. Mushtaq Ahmad

The current fiscal year to end on the 30th of June is unique in many respects as it has experienced an unprecedented volatile political scene worsening further the economy already struggling to cope with both external and internal shocks. This is reflected in pressure on prices, widening twin gaps in external sector and budget, lackluster industrial and agricultural productivity leading to slackening growth tempo, stagnating domestic savings, bulging borrowing both - external and internal, worsening income inequalities, and crippling wheat-energy crisis to mention a few out of a big list of multiple economic woes.

The main coalition partners have long been criticising the previous regime for its failures on these very same accounts and won the election on their promise to salvage the economy. This paper is targeted to see how far the new budget has addressed the stated issues. The foregone conclusion is that it falls far short of offering a meaningful strategy to resolve these issues, leaving alone the sheer disappointment of the PPP’s main constituency consisting of labour, poor peasants and tenants.

Let’s take up inflation first, a mother of many economic ills which is not that easy to control once it permeates the economy. In our case the inflationary impulses have had taken roots very consistently over the last few years. This year inflation has soared up to new heights, reaching the double digit. Food inflation has reached the record high level mostly due to the wheat shortage - never experienced in such desperate state in the sixty year history of the country. Food shortage and high energy prices can only be partly blamed for high headline inflation (name given to overall inflation). In our view targeting inflation has been the stable factor all these years. To compound it further, government pursued expansionary fiscal policy, and the central bank did not show any reluctance in following an accommodative monetary stance. In this budget like so many past years, inflation has been targeted again and that at 12 per cent for the year 2008-9, even higher than the last year. The size of the budget is proposed 20 per cent higher than the last year, albeit projecting lower fiscal deficit at 4.2 per cent. Like past years this level of fiscal deficit is likely to be breached again. Even leaving that aside, the higher budget size itself is inflationary.

The central bank has increased the interest rate, and the budget has also announced increase in interest rate on national saving schemes. Higher interest rate means increase in the cost of investment which will eventually be passed on to the retail prices. Despite the resistance supported on tested economic rationale of inflationary spiraling effect, the support price of wheat has been increased and the new budget has promised to review it again in the coming sowing season, hinting at further increase. Subsidies on POL and electricity have been slashed in the budget and regardless of its justification it will be having all embracing inflationary impact. Two percent increase in sales tax across the board; increase in duty on cement and increase in import duty on many imports used as industrial inputs will only compound the inflationary effect.

This year GDP growth has come mainly from the service producing sectors. The budget has imposed duty on the fast growing sectors of banking, insurance and telecommunication. This is not only prone to fuel inflation but will also be having discouraging effect on growth.

GDP growth has suffered mainly due to a meager growth of 1.5 per cent in agricultural output (which itself is on account of sizable decrease in the production of wheat and cotton) and steep fall in large scale manufactures. Natural vagaries occasionally affect agriculture but the key factor to push its output is irrigation water. Budget allowed some subsidy on DAP but no measure has been proposed to rectify shortage of irrigation water. The solution lies in increasing the dams capacity, specifically of Kalabag dam. Despite big landlords’ domination in both houses, the dams’ priority (already recognised even at the World Bank level and the President once announced to take it up) appears to have been sidelined.

The budget has recognised that our industry has lost competitiveness but instead of providing necessary incentives it has been over burdened with higher sales tax and duties. With holding tax has been increased under the pretext of progressivity norm. POL and electricity have been made expensive, and the services sectors which serve as infrastructure for industry have also been put under financial pressure. The budget has reduced duty on some items which are locally produced and as a result the protection available to the local industry has been withdrawn.

The budget has let free all possible inflation fueling factors, such as cost push, demand pull, supply reduction, budget targeting and inflationary anticipations. Wheat shortage has been the worst development on many accounts, caused mostly due to hoarding and smuggling. Even the Prime Minister stated in the assembly that some notables are involved in this unfair business. At the moment this is the most serious problem of the country but surprisingly, no corrective step has been announced to check this. Unless the free wheat market supported with wide government distribution network is ensured, no amount of import would help what may come but it will increase pressure on the exchequer. The budget has easily bypassed this. The energy crisis, a serious concern for the whole nation, has met a similar fate.

The budget has announced to reduce the current fiscal deficit of 6.5 per cent to 4.7 per cent next year. It has shown the intension to reduce the current account deficit from 7 per cent of GDP to 6 per cent and to augment the forex reserves to a minimum of $12 billion. The former deficit is intended to be reduced by fixing higher targets for tax and non tax revenues. The GDP growth is already on a downward slide and its continuation in the next year is recognised in the budget by targeting it at 5.5 per cent. But a host of factors just surveyed point to a fast sliding of the growth as compared to the target. In the wake of the tax measures budgeted, two things will be prompted to work. Application of the Laffer law will be certain, that is, after a certain stage the increase in tax rate reduces total tax receipts. Secondly, higher duties on small items, in this context the luxury items will promote smuggling and black economy. In fact this was primarily the main concern in the past when such duties on these items were last reduced.

The targeted reduction in the current account deficit (CAD) is expected from the proposed higher duty on the import of big cars and luxury vehicles. The users of these vehicles are rich people, whose demand for such things is mostly inelastic, and secondly, their share in the total import bill is not so high to bring about any significant reduction in CAD by one or two percent decrease in their imports. There are three main reasons for higher CAD: high prices of POL, lower exports growth relative to import growth and inadequate foreign capital inflow. The budget can not do any thing regarding the first factor, although the second falls in its domain but we have not noticed any substantial measure announced in the budget to reverse the existing export-import ratio. Exports mainly come from industrial and agricultural production, and the budgetary measures offer little incentives to this. So there are minimal chances for export to grow next year unless the trade policy which is usually announced early July comes up with some incentives. The adjustment made in import duties is not likely to affect the current trend in imports. Nevertheless there is a possibility that imports may fall if the rupee continues under pressure and some significant depreciation occurs which is most likely to happen. The official expectations of having capital inflow of $3 billion as also indicated by the central bank governor if realised would provide some relief but the speedily falling forex reserves indicate that there is strong need for massive efforts to check the continued erosion in BOP.

Poverty and unemployment is the topmost problem in the country. The budget has continued the past regime’s schemes of internship and rozgar loaning but these have so far had a minimal impact, and their continuation would not have much difference either. Under Benazir Income Support (BIS) scheme envisaging disbursement of Rs34 billion to 3.3 million poorest of the poor households, financial assistance of Rs1000 per month would be provided to each family whose average size is 6 members. This cash could buy each family only fifty kg flour at the current market rate, but what about the other basic needs of the poor? The World Bank has recently revised the one dollar per person a day poverty line to $ 1.25. How does the BIS assistance compare with this? Same is the case of increasing the minimum wage to Rs6000. The budget has announced 20 per cent increase in the salaries of government employees; this will partly relieve them of the inflationary pressure but none of them regardless of the grade could possibly afford to save Rs2.4 million, an amount required to buy a low cost D-type apartment under the PM Housing Scheme advertised in this daily last Friday.

To end, the budget, instead of having been geared towards improving the health of the economy, surprisingly targets to lowering GDP growth and increasing inflation rate next year. Marvelous budgeting, planning and programming!