Monday April 22, 2024

Budget 2023-24: more debt for the people

By Ammar Habib Khan
June 10, 2023

THE outlay for Budget 2023-24 is estimated to be Rs14.46tr, of which almost half will be allocated towards servicing of debt. What else does Budget 2023-24 say? It allocates around Rs716bn to pensions, while military expenditure gets around Rs1.8tr. Budget 2023-24 also gives a more than 30 per cent increase in salaries across the board. This will likely trigger a wage spiral that can in turn induce further inflation.Roughly Rs920bn has been allocated to infrastructure development under the Public Sector Development Program. How does one read that? With elections potentially around the corner, accelerated deployment of the PSDP may tilt election results in a certain direction.Barely any work has been done to rationalize the expenditure of an already bloated government machinery; in fact, expenditures continue to increase unabated. The budget framers have evidently put little -- if any -- thought into how all this expenditure will be actually financed. The government expects to increase tax revenue to roughly Rs9tr, ironically to be generated from an ever-shrinking formal segment of the economy.

Almost 75 per cent of the economy -- which includes agriculture, retail and wholesale trade, and real estate, etc -- largely remains untaxed, resulting in significant distortions to the economy. Budget 2023-24 also continues to squeeze the formal sector. The imposition of additional super tax will further discourage investment in the formal economy. It doesn’t stop here. That will end up having a direct impact on job creation, as well as the ability to generate more taxes. As the formal segment is taxed more, it will eventually result in higher prices for the end-consumer. That will further drive inflation, while also inducing lower production volumes, and consequently lower taxes.Through excess expenditure, the government is embarking on an expansionary fiscal policy, while constraining the ability of private businesses to invest and create jobs. The expansionary policy is being driven by taking on more debt to fund government largesse.

It is estimated that the federal government will pay Rs7.3tr in mark-up expenses, to just service both external and domestic debt, making up almost 80 per cent of federal tax revenue. On a net revenue basis, debt servicing will make up more than 95 per cent of the same. This effectively means that whatever net revenue the federal government is generating, almost all of that will be allocated towards debt servicing.In essence, the government will be funding all development and other expenditures by taking on more debt. It is also important to consider the prevailing historically high interest rates. As the government takes on more debt, the interest rate may potentially increase further, exerting more pressure on the fiscal position.

Friday’s budget has also imposed a withholding tax of 0.6 per cent on cash withdrawals for tax non-filers. The last time such a tax was imposed, it resulted in significant outflow of deposits from the system, increasing currency in circulation in the economy. As deposits left the system, it led to a thriving informal economy, which continues to live on unabated -- and untaxed. The imposition of a similar tax again may have dire consequences.

In such a case, it is entirely possible that there is an exodus of deposits from the system. This will result in an increase in currency in circulation. And, as deposits leave the system, the capital available from which the government can borrow will also reduce, once again resulting in a higher interest rate.In an environment where availability of formal capital is already scarce, an exodus of deposits from the system can potentially increase the cost of borrowing. In effect, the budgeted amount for mark-up expenses may be dwarfed by the actual amount as interest rates increase. This can result in a debt-death spiral, where the government takes on more debt to pay mark-up on earlier debt, at increasing interest rates. The logical conclusion of such a spiral is either hyperinflation or a restructure of debt, as can be seen in the case of many other economies that have restructured their debt in the last few quarters.

what could have been done instead? The government should have carefully developed Budget 2023-24 to target a lower fiscal deficit through a mix of expanded tax net, and rationalization of government expenditure. A refusal to rationalize losses of state-owned enterprises effectively means that the government will continue to fund losses at historically high interest rates. With an increase in interest rates, the fiscal deficit goes up too -- and as the fiscal deficit continues to expand, inflation will run unabated.The risk of an expanded fiscal deficit, further fueling increase in interest rates and inflation is real. Expenditures of the government continue to increase, as does inflation. The population growth rate of the country -- at 3.6 per cent -- remains in excess of the targeted growth rate of 3.5 per cent. his effectively means that per capita real income -- the levels of which have stayed static over the last five years -- may actually erode further.

The economy is stuck in a structural rut, and Budget 2023-24 fails to pull it out of an entrenched stagflation. The inability to address these issues -- in fact, ignore them -- may have disastrous consequences that lead potentially to hyperinflation. The government had an opportunity to make amends, and reduce the fiscal deficit, but it continued to double down on expensive debt. It may have bought just a little bit more time for itself, but in doing so has pushed the people of the country under more debt.