Can't connect right now! retry

add The News to homescreen

tap to bring up your browser menu and select 'Add to homescreen' to pin the The News web app

Got it!

add The News to homescreen

tap to bring up your browser menu and select 'Add to homescreen' to pin the The News web app

Got it!

June 23, 2019

Budget for an economy in stagflation


June 23, 2019

There’s a strong sense of deja vu as one goes through the Economic Survey of Pakistan for the outgoing financial year (FY19) and budgetary proposals for the upcoming financial year (FY20).

In the face of sputtering economic growth and galloping prices – stagflation as the unenviable combination is called – the government has set an ambitious revenue target, which draws upon even greater contribution from the existing taxpayers. It’s like a heartless capitalist for whom the only way to shore up output is to whip the workforce into working longer hours.

Most of the key macroeconomic indicators registered a downturn during FY19, which marked the first year of the PTI government. GDP growth decelerated to 3.3 percent compared with 5.5 percent (revised downward from 5.8 percent) in FY18 and against the 6.2 percent ambitious budgetary target. Agriculture growth fell to 0.9 percent from 3.9 percent. Manufacturing registered negative growth of 0.3 percent compared with 5.4 percent a year ago. The 4.7 percent expansion of services, though trailing well behind 6.3 percent in FY18, has imparted a modicum of respectability to the overall growth figure.

For a labour-abundant economy, the dismal performance of agriculture and manufacturing ushers in substantial job losses as well as bids up prices. Not surprisingly, the average consumer price inflation (CPI) rate during FY19 went up to 7 percent from 3.9 percent a year earlier. The latest figures for the unemployment rate have not been reported but it can be safely conjectured that it has gone up. Due in part to the rupee’s depreciation and in part to the economic slowdown, the per capita income has come down to $1497 from $1652 in FY18.

The two fundamental indicators of an economy’s strength are the share of savings and investment in the national income. Domestic savings-to-GDP ratio came down to 4.2 percent from 5.1 percent, while investment-to-GDP ratio declined to 15.4 percent from 16.7 percent. In all, total investment registered meagre growth of 2.8 percent compared with 12.4 percent a year ago. A fall in investment is also job shedding.

The outgoing fiscal year is projected to close with fiscal deficit of 7.2 percent of the GDP compared with 6.8 percent in FY18 and against the budgetary target of 4.9 percent. The high fiscal deficit had been a convenient stick in the hands of the PTI to beat the PML-N government with. The current account deficit, however, has come down to $13.23 billion from $18.49 billion in the first 11 months of the outgoing financial year, as trade deficit fell from $28.71 billion to $26.11 billion. However, this achievement is undergirded by fall in imports to $48.45 billion from $51.46 billion rather than an uptick in exports, which have remained almost stagnant ($22.34 billion in FY19 compared with $22.75 billion in FY18) despite a massive depreciation of the domestic currency. The import compression is little cause for celebration, as it is symptomatic of the contraction in the economic growth rate.

When an economy slows down, jobs are shed and incomes erode, which puts a damper on aggregate demand. Businesses respond by cutting back on investment, which hobbles economic expansion. The effect is more pronounced when deceleration of the economy is accompanied by an upward price movement. Stagflation stumps even the most astute of policymakers. Not surprisingly, in FY20, the economic predicament is projected to become gloomier: GDP growth will decelerate further to 2.4 percent, while inflation will go up to 13 percent.

The logical question that arises is: why have almost all economic indicators cut a sorry figure? Was the PML-N government far more adroit at economic management than the PTI’s is? While a simple answer to the first question will entail an affirmative answer to the second question, we need to avoid the fallacy of over-simplification and instead go deeper. The outgoing financial year is not a one-off. Such things have occurred in the past as well.

For instance, FY08, the last year of the PML-Q government, closed with 5 percent GDP growth, which slumped to 0.4 percent in FY09, the first year of the PPP’s five-year term. Manufacturing, which grew 6.1 percent in FY08, registered negative growth of 4.2 percent in FY09. CPI inflation leapt from 12 percent in FY08 to 21 percent in FY09. It’s not that the PML-Q was a dab hand at running the economy, while the PPP comprised an incompetent lot. The reason was that the robust growth during the PML-Q government didn’t rest upon strong fundamentals. External and internal deficits had continued to build up during the PML-Q tenure, such that FY08 concluded with 8.2 percent current account deficit, 12.3 percent trade deficit and 7.3 percent fiscal deficit.

By the same token, FY18, the final year of the PML-N term, closed with 6.8 percent fiscal deficit and 5.7 percent current account deficit underpinned by $37 billion biggest ever trade deficit. Faced with the twin deficits, the PPP government had no choice but to go to the IMF to bail the economy out. In the face of a similar situation, the PTI has done the same – albeit, belatedly. In both cases, capital inflows from the lender of last resort were made conditional upon adoption of stabilization (read: contractionary) policies.

Thus hemmed in by massive internal and external deficits and the multilateral donor’s familiar prescription of leaving the economy largely to the market, the government has introduced a budget that has left everyone howling. Gross and net revenue receipts (net revenue equals gross revenue of federal government minus provincial share) target is Rs6.71 trillion and Rs3.46 trillion respectively compared with the revised gross and net revenue target of Rs5.03 trillion (33 percent increase) and Rs2.56 trillion (35 percent increase) respectively for FY19. These targets are overly ambitious given that the pace of economic growth is set to slacken further.

The targeted FBR tax revenue for FY20 is Rs5.55 trillion, which is nearly 34 percent higher than the Rs4.15 trillion receipts for FY19. Direct and indirect taxes will account for Rs 2.08 trillion (37 percent), and Rs3.47 trillion (63 percent) of the total tax revenue. Thus, as in the past, indirect taxes, which as a rule are both regressive – because everyone regardless of their income level pays the same tax – and inflationary – as in the end tax is borne by the consumer – will shoulder the lion’s share in revenue burden. Not only that, the over 25 percent increase in direct taxes will be accounted for by downward revision of minimum taxable income to Rs0.6 million from Rs1.2 million and jacking up tax rates on personal income for the salaried class. Thus the existing taxpayers will bear the brunt of the proposed taxation measures.

It goes without saying that Pakistan needs to shore up tax-to-GDP ratio, which at present is as low as 12.6 percent. In the upcoming financial year, the ratio will be racked up to 14.4 percent. But the target will be achieved by relying upon the convenient, run-of-the-mill means – though this time they will sting the taxpayers more.

The total expenditure envisaged for FY20 is Rs8.28 trillion, which consists of Rs7.28 trillion current expenditure (compared with Rs4.78 trillion budgetary allocation for FY19 and actual spending of Rs5.58 trillion) and Rs0.950 trillion development expenditure (compared with Rs1.15 trillion budgetary allocation for FY19 and actual expenditure of Rs0.829 trillion). Notwithstanding the PTI’s professed commitment to austerity, current expenditure in the outgoing fiscal year went up 17 percent over the budgetary allocation and will further go up 30 percent during the upcoming financial year. This shows how difficult it is for the government to tighten its purse strings. The cuts in development spending are understandable as stabilization policies give uplift a short-shrift.

In fine, the budget will accentuate demand compression, which will put further brakes on growth and employment generation. That’s why stabilization policies are remarkably unpopular and entail an enormous political cost. Let’s see how the ruling party comes to terms with such challenges.

The writer is an Islamabad-based columnist.

Email: [email protected]

Twitter: @hussainhzaidi