IT was rather amusing to watch the minister of state for economic affairs reproach the previous government, of which she was part in the same capacity, for its ‘faulty’ economic policies while presenting the budget for the new fiscal year. It was equally amusing to watch her claim that the PPP government, having a needlessly large cabinet despite economic crunch, is committed to living within its means as part of efforts to stabilise the economy. But this is what the political economy of Pakistan is where people in power want an increased share of the shrinking pie at the cost of allocative efficiency.

The budget is both a political and economic document. On the economic side, it is a statement of the fiscal policy by which the government makes decisions about public revenue and expenditure with a view to affecting output, employment and inflation in the economy. On the political side, the budget is used to reward, appease or penalise certain constituencies. Both the economic and political aspects of the budget are determined by the constraints within which every government works. The same is true of the budget for the fiscal year 2009-10 (FY10).

Politically and economically, the three perennial constraints which every government in Pakistan has to face while budgeting are the massive public debt, the need to maintain a huge military establishment, and the lack of tax culture. The first two constraints dictate that a large portion of the public expenditure is allocated to debt servicing and defence, while the third constraint ensures that the public revenue, particularly

from direct taxes, lags behind increase in government expenditure and growth of GDP. The result is not only increase in fiscal deficit but also misallocation of resources.

The government will be spending Rs2.48 trillion during FY10. Whereas the current expenditure of Rs1.69 trillion accounts for 68.43 per cent of the total expenditure, the Rs783 billion development expenditure constitutes only 31.57 per cent of the total expenditure. A developing country like Pakistan needs to spend far more on development projects. But the above mentioned constraints do not allow the Pakistan government to do so.

An amount of Rs1.18 trillion — which makes up 69.82 per cent of the current expenditure — will be spent on general public services (including debt servicing and transfer payments), and Rs343 billion—which constitutes 20.29 per cent of current expenditure — will be spent on defence products and services. The proposed defence spending for FY10 is 15.88 per cent higher than the outgoing fiscal year’s budgetary allocation of Rs296 billion and 10.29 per cent higher than the actual spending of Rs311 billion. As in the past, this fiscal year as well, actual defence spending may go up primarily due to stepped-up fight against terrorism.

Thus defence and general public services expenditure together account for about 90 per cent of current expenditure and 62 per cent of total expenditure. Debt repayment is an obligation that the Pakistan government owes to foreign countries and institutions as well as its own nationals. The massive military expenditure, on the other hand, is rooted in the country’s political system which is dominated by the armed forces no matter which party is in power or what robe — democratic or despotic — the government puts on.

It is easier for a party in opposition to criticise massive military allocation. But the very first lesson the same party learns when it enters the corridors of power is “don’t mess with the defence.” The Pakistan government’s discretion regarding allocation of resources starts only after meeting the expenditure on these two heads. At present, the armed forces are engaged in putting down insurgency in the north-western part of the country and therefore it is understandable that a sizable part of the national pie is allocated to supporting that effort. But let no one labour under the impression that once that insurgency is quelled, the defence expenditure will come down.

Scarcity of resources necessitates a trade-off among competing needs. If a country spends too much on producing or procuring defence goods and services, it will have too little to spend on civilian goods and services. Hence, not surprisingly, governments in Pakistan have been making meagre allocations to health and education — the two capital indicators of human resource development (HRD).

The FY10 budget allocates Rs31 billion to the education sector (compared with the outgoing year’s 20 billion) and Rs23 billion to the health sector (compared with the outgoing year’s 14 billion). Though allocations for both health and education have been substantially increased, they collectively (Rs54 billion) still account for only 2 per cent of the total expenditure, which is well below the desired level. Poverty alleviation and employment generation are among the basic policy objectives of the government, which require substantial investment in human capital development. Meagre budgetary allocation for health and education will impede the attainment of this objective.

Expenditure is one side of the budget, whose other side is revenue. Projected tax revenue during FY10 is Rs1.37 trillion including direct taxes of Rs565 billion and indirect taxes of Rs815 billion. The revenue target envisages 16.10 per cent growth in estimated receipts of Rs1.18 trillion in the outgoing fiscal year. The fiscal deficit of Rs722.5 billion, 4.9 per cent of the GDP, would be met partly through domestic resources (Rs457.6 billion) and partly through external financing (Rs264.9 billion). The 4.9 per cent fiscal deficit will be 0.6 percentage points higher than that for the outgoing fiscal year (FY09) but 2.7 percentage points lower (7.6 per cent of GDP) than that during FY08.

Although fiscal deficit during the outgoing fiscal year is much lower than that of 7.6 per cent of the GDP during the previous year, the “feast” has been accomplished by reducing developmental expenditure (federal government) from Rs 371 billion to Rs219 billion rather than by increasing tax-GDP ratio, which has fallen to 9 per cent of the GDP. As the State Bank of Pakistan (SBP) has noted in a recent report, a sharp cut in development spending is neither sustainable nor desirable, because the government is required to increase spending on human capital development and widening the social safety net as an effective antidote to extremism.

In FY10 as well, developmental spending may have to be slashed as the government is counting on highly uncertain capital receipts of Rs178 billion from the Friends of Pakistan and Rs50 billion for internally displaced persons for budgetary support.

In order to contain the public expenditure, the government has decided to cut power subsidy by 40 per cent to Rs66.7 billion from 111.64 billion in the outgoing fiscal year. The subsidy on oil has already been done away with. While the cut in subsidies will help reduce fiscal deficit, it will add to inflationary pressures in the economy. This will tell upon both consumers and businesses and may impede other objectives of the government, such as reducing current account deficit, increasing productivity of the economy and raising the level of savings.

Productivity of the economy will go down as resources will be diverted to speculative or non-productive activities such as investment in real estate. Already during the outgoing fiscal year, large scale manufacturing has registered negative growth of 7.7 per cent. Surge in prices of inputs will push up the cost of production and thus drive up the final price of exportable goods making exports less competitive in the international market. Savings will be discouraged partly due to reduction in real incomes, the single most important factor behind savings, and partly due to increased consumer spending in anticipation that prices will go up further. Finally, increased inflation will have enormous social cost in that it will hit hardest the salaried class and the poorer sections of society.

The budget provides for 15 per cent increase in salaries and pensions of government employees. If the purpose was to mitigate the problems of the masses, then the salary and pension increase would not serve that objective unless inflation was brought down significantly; rather it might aggravate their problem. The reason is simple: in the absence of substantial increase in output or price control, any increase in salaries and pensions is likely to be offset by a proportionate, if not greater, increase in prices. The result will be that the real incomes will further come down.

The 15 pc increase in wages means that, people earning Rs5,000 per month will get only Rs 750 increase, while those earning Rs30,000 per month will get Rs4,500 increase. But prices will increase for both by the same margin. It is pertinent to mention that lower income people spend a higher portion of their total income on essential items than the people falling in the upper income bracket. Thus increase in wages should be accompanied by price control of basic commodities and services like transport by keeping an eye on cartels and artificial shortages.

Essential as increase in salaries was, the government should have provided greater relief to the lower income employees than those with higher income by announcing higher percentage wage increase for the former. But then the political economy did not warrant such a decision.