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Monday June 17, 2024

Budget deficit, root of all evil

By Farrukh Saleem
June 10, 2023


Our true challenge lies in the realm of politics rather than economics. The Ministry of Finance has announced a projected budget deficit of Rs6,923 billion, this is a decision driven by political considerations rather than economic factors. It is crucial to recognize that a budget deficit is the catalyst for a hundred economic ailments. Let’s examine a selection of these afflictions: Increased national debt: When our government runs a budget deficit, it must borrow to bridge the gap between its expenditures and revenues. Over the past year, the government has borrowed an average of Rs41 billion a day every day of the year. Over the past year, our total debt and liabilities have gone up from Rs59.7 trillion to Rs72.9 trillion Higher interest payments: When our government runs a budget deficit, it must borrow to bridge the gap between its expenditures and revenues. This increased demand for borrowing puts upward pressure on interest rates. Inflationary pressure: To finance its Rs6,923 billion budget deficit, the government will resort to issuing government bonds. When the State Bank of Pakistan (SBP) will purchase these bonds or provide funds to cover the deficit, SBP will effectively inject new money into the economy. This increase in the money supply will lead to inflation.

Higher taxes: To finance its Rs6,923 billion budget deficit, the government will increase tax rates or introduce new taxes. As per my calculations, an increase in tax rates will not increase government revenue because of the elasticity of the taxed goods, behavior of taxpayers and the prevailing economic conditions. Crowding out private investment: When a government runs a budget deficit, it needs to borrow money to finance its spending. This increases the demand for loanable funds in the economy. As a result, there is increased competition between the government and private sector borrowers for the available funds. The increased demand from the government drives up interest rates, making borrowing more expensive for private businesses. Higher interest rates thus discourage private investment by making it less affordable and reducing the potential return on investment.

Weakening of the rupee: The government will monetize the deficit by expanding the money supply leading to inflationary pressures. Inflation will erode the value of the rupee. Higher interest rates: The government will borrow to fill its deficit. This government borrowing will absorb a significant portion of available funds in the market. This will reduce the funds available for private investment by businesses. With less capital available for investment, borrowers will be forced to compete for the limited pool of funds, driving up interest rates. Higher risk of default: This year’s Rs6,923 billion budget deficit will contribute to the accumulation of additional government debt. Our debt burden is already unsustainable. The time that our government will not be able to service its debt obligations is not too far. This will lead to a higher risk of default. Dependence on foreign lenders: The government needs Rs6,923 billion. When the local banks or the domestic bond market will run short of funds the government will turn to foreign lenders to finance its deficit. The larger the budget deficit, the greater the reliance on external borrowing, thereby increasing dependence on foreign lenders. In conclusion, the ultimate decision to run a budget deficit is made by governments based on their political priorities and objectives. To be certain, the budget deficit is the real disease, while the rest are all symptoms of the disease.