Of beaten paths and bleeding budgets

[Mehwish Pervez]

Of beaten paths and bleeding budgets
Dr Muhammad Yaqub
Saturday, March 15, 2014

Although the next budget year will start on July 1, both the federal and provincial governments are likely to start preparing their budget estimates for FY15 very soon. The provinces have become relatively more important recently in setting the direction of public sector expenditure, but the federal government still has a dominant role in the overall fiscal situation of the country for three reasons.

First, the bulk of revenue continues to be collected by the federal government, although a larger share of the tax revenue is now being distributed automatically to the provinces under the latest NFC Award. This has created an anomalous situation under which the federal government gets the blame for taxation and the provincial governments take the credit for spending. The correlation between spending and taxing has become ambiguous leading to the inability of the public to understand the link between tax payments and availability of public goods and services.

Second, the two major heads of expenditure are debt servicing and defence, which fall in the domain of the federal government. Both these expenditures are based mostly on non-economic considerations or pre-determined parameters and need to be met in one way or the other. At the same time, the relatively slow growth in revenue, new revenue sharing formula between the federal and provincial governments and the rising level of debt servicing and defence expenditure have increasingly shrunk the fiscal space for the federal government.

Third, only the federal government has the authority to print currency notes and indulge in borrowing from internal and external sources to finance public-sector operations. It gives leverage to the federal government in targeting the level of the budget deficit and the method of its financing.

In these circumstances, if the federal government is to correct its precarious budgetary situation, not only does it need to restructure the taxation system and reset its expenditure priorities but also totally revise its approach to budget-making.

But the PML-N government has continued to follow a beaten path to budget preparation and implementation and has been unable to stop the bleeding of the budget and its adverse consequences for the economy. It has indulged in some ‘statistical engineering’ and window dressing, which could not conceal the underlying weakness of the budget. If the government does not adopt a new approach to budget-making, the following scenario is likely to emerge in preparing the budget for FY15:

First, blaming the previous government for economic mismanagement, the PML-N government will highlight its great economic achievements in the current fiscal year based mostly on fictitious data. It will show a low budget deficit for FY14 based on cooked up data and then proceed to make fake projections and false promises for the next budget year.

Second, it will prepare the budget for FY15 based on an erroneous database, flimsy assumptions for the future and distorted views on economic policies, and come up with a hotchpotch of a budget. In particular, the budgetary expenditure targets will be pitched high based on the assumption of large availability of foreign loans, substantial sale proceeds from privatisation, an unrealistically high growth in tax revenue without any tax reform and underreporting of the defence and debt servicing expenditure.

Third, in introducing the budget in the National Assembly, the finance minister will try and hoodwink the public into believing that the government is making a serious effort to address their economic problems, include some eye-catching populist schemes supposed to help the poor, pamper the business community, and use political sloganeering that will receive extensive clapping and table thumbing in the National Assembly. The finance bill will get passed without anybody caring to read it and the budget will begin to unravel soon after its passage.

For the sake of the country and the majority of the people, the PML-N should abandon the approach to budget making that has been going on for a long time, and adopt a new one on the following lines:

First, the budget-making exercise should not be undertaken by the Ministry of Finance alone with no checks and balances and no accountability mechanism in place. The Planning Commission of Pakistan, the Federal Board of Revenue, and the State Bank of Pakistan should not be treated as subordinate departments of the Ministry of Finance but allowed to give their professional input in budget making on an equal footing. Growth strategy and monetary and exchange rate policies should be coordinated with the fiscal policy and not subordinated to it.

Second, the integrity of data should be restored by producing and using it professionally and honestly. The practice of fudging the economic data to justify certain preconceived conclusions should be replaced by a professionally- established data base without manipulations.

Third, the budget exercise should be based on a national agenda/commitment to move towards self-reliance and avoid further large increases in the domestic and foreign borrowing by the government. Such an approach will lay bare the real budgetary situation both for the politicians and the public and they will begin to focus on the enormity of the task ahead and the urgent need for fiscal reforms.

Fourth, a realistic estimate of the debt servicing liabilities of the government and the minimum defence needs of the country should be incorporated in budget estimates so that their subsequent revision does not strain the budget. In the matter of debt servicing, a careful projection should be made of the level of domestic interest rates that should be derived from the monetary policy and the movement of the nominal exchange rate that should be based on fundamental developments likely to take place in the balance of payments.

Fifth, a comparison of the estimated revenue from the existing tax base with the estimated expenditure on debt servicing, defence and civilian current expenditure would show that there is no fiscal space left for development expenditure and in fact the projected primary budget deficit would turn out to be large. Under the circumstances, development expenditure should not be artificially inflated without the backing of real resource availability. Ambitious and unrealistic revenue and expenditure targets that are not backed by concrete measures to achieve them will further erode the credibility of government policies and programmes.

Sixth, the extent of foreign borrowing that is possible on the basis of sound debt management policy and any borrowing from the domestic banking system that is consistent with a sound monetary policy would be very limited and should be carefully calculated. On completing this exercise objectively and professionally, the government will realise that a major taxation effort is needed not only to finance development expenditure but also to cover a part of the current expenditure.

At that stage, and with this approach, the government would understand its real fiscal dilemma and difficult policy choices. It would have to limit development expenditure, rely on excessive borrowing or undertake further tax reforms to finance the development expenditure. The logical choice ought to be a fiscal effort focused on expansion of the tax base, elimination of tax loopholes and improvement in tax administration.

The writer is a former governor of the State Bank of Pakistan.Email: doctoryaqub@hotmail.com
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