Salvaging The 7th NFC Award
By Dr Ashfaque H Khan
In the recently concluded Annual Conference of the Pakistan Society of Development Economists, experts deliberated extensively on the issues of the NFC Award and fiscal decentralisation. The general consensus that emerged was that the 7th NFC Award was a political, and not economic, measure; was concluded in haste with little homework done on its macroeconomic consequences; and more work would be required urgently to salvage the Award. This consensus was in line with my argument (Oct 5, 2010) that the 7th NFC Award was one of the ten economic blunders of the present government.
Pakistan’s macroeconomic management had remained centralised until 2009-10. However, the 7th NFC Award and the 18th Amendment contributed to its decentralisation. Pakistan’s is passing through the most difficult phase of its economic history. The large budget deficit, rising debt-servicing, unsustainable debt burden, crowding out of the private sector, declining investment, slower economic growth, rising unemployment and poverty, and double-digit inflation are some of the key challenges that Pakistan is confronted with. The root cause of these challenges is the persistence of a large fiscal deficit, which has averaged 6.3 per cent of the GDP in the last three years. A deficit of this magnitude is “the mother of economic problems.”
It is commonly argued that a government which succeeds in maintaining financial discipline by keeping budget deficit low is bound to be a successful government. It will have ample resources to invest in people (health and education) and infrastructure. Unfortunately, governments in developing countries like ours are inherently “deficit biased.” They love to spend but hate to collect resources through taxation, and as such see their budget deficits rising, which in turn, gives birth to macroeconomic crises. Such a policy is bound to create economic instability which, in turn, promotes political instability. Political instability, in its turn, causes economic instability. This is exactly what we are observing in Pakistan today.
The only way we can take the economy out of the current crisis is to maintain financial discipline. Financial discipline is the sine qua non for economic prosperity. Can any government succeed in maintaining financial discipline in the post-7th NFC Award situation and following the 18th Amendment? Will we be more fiscally responsible in the decentralised setup? These questions are vital for Pakistan’s future macroeconomic management.
Pakistan’s macroeconomic stability will depend crucially on the financial discipline of the provincial governments going forward. Under the 7th NFC Award, 56 per cent of tax resources will be transferred to the provinces this year and 57.5 per cent in the remaining years of the Award. Including other transfers, almost 60 per cent of the resources will be transferred to provinces, which have little financial discipline and capacity to spend prudently.
Did we analyse the macroeconomic consequences of this Award before finalising it? The massive transfer of resources to provinces is taking place at a time when the federal government’s legitimate expenditure is growing rapidly. For example, interest payments were more than doubled in the past three years (from Rs365 billion to over Rs800 billion this year), surging security-related expenditure on account of geo-strategic developments and the war on terror, power-sector subsidies reaching over Rs175 billion, and rotten public-sector enterprises draining over Rs250 billion per annum from the federal exchequer. Have we taken into account these rapidly increasing expenditures of the federal government? Have we left sufficient resources for the federal government to meet its growing legitimate expenditure? The answer is obviously no. It is in this perspective that experts believe that the 7th NFC Award was political, devoid of economic foundation.
The deficits of both the federal and provincial governments together provide overall or consolidated fiscal deficit for Pakistan. Historically, the federal government’s budget has always been in large deficit. Provincial governments used to generate cash balance surplus to arrive at a targeted consolidated budget deficit. For example, in Budget 2010-11 (the first budget under the new NFC Award), the budget deficit of the federal government was targeted at 5 per cent of the GDP and provincial governments together were expected to generate 1.0 per cent of GDP surplus to arrive at a consolidated deficit of 4.0 per cent of GDP.
The provincial governments, instead of presenting surplus budgets, presented deficit budgets, despite the fact that additional resources of over Rs500 billion were to be transferred to them. As a result, Budget 2010-11 never saw the light of the new fiscal year and died prematurely. Presenting deficit budgets in the midst of massive transfer of resources was the height of fiscal indiscipline on the part of the provincial governments.
What will be the consequences of such an undisciplined attitude of the provincial governments? Setting a consolidated budget deficit target by the ministry of finance has become meaningless. Can the federal government deliver on the budget deficit target agreed with the IMF? The answer is no. Pakistan’s future fiscal deficit will be determined by provincial governments. In other words, Pakistan’s macroeconomic management, economic stability, growth and development have now been shifted to the provinces, where financial indiscipline reigns.
Pakistan can come out of the present economic crisis only if it maintains financial discipline by keeping the budget deficit low. In its present form of resource transfer under the NFC Award, this is next to impossible. Unless some hard constraints are put in place, in the form of binding the provincial governments to deliver required surpluses to meet the consolidated budget deficit target, Pakistan’s economic conditions will continue to deteriorate. The federal and provincial governments must sit down, for the sake of Pakistan, to devise binding constraints and get them approved by the National Economic Council. The sooner we move, the better it is for the country.