The ‘stabilisation’ budget will eat into GDP growth
The federal government has described its budget for 2020-21 in terms of crisis management. Its most prominent feature is that it doesn’t take into account the behaviour of economic agents. Most of the analysis and commentary in the media since the budget speech has been dominated by an accounting mentality. The evil of such an approach lies in its preoccupation with the short-term and its failure to pay adequate attention to long-run objectives. In this piece, we attempt to show how the various measures proposed in the budget are likely to impact a long-term goal i.e. growth.
A careful reading of budget philosophy and approach informs us that the budget is predisposed towards macroeconomic stabilisation where growth will get secondary importance. Therefore, it features an effort to strike a balance between expenditures necessitated by the Covid-19 pandemic and fiscal deficit; keeping primary deficit at a sustainable level; rationalising the subsidy regime and a continuation of the IMF programme. A glaring contradiction is an attempt simultaneously to provide a stimulus package and introduce austerity measures. One realises quickly, however, that in the context of this document, the word ‘stimulus’ is a misnomer as the government has tried to tread an adjustment path.
The budget document sets the nominal GDP growth target at 9.6 percent and ‘real’ growth at 2.1 percent. In addition, an accommodative monetary policy is assumed based on a flexible exchange rate regime with moderate inflation of 6.5 percent along with low international crude oil prices. Having made these assumptions, the policy makers expect a stable interest rate environment as the allocated amount for domestic debt servicing has increased by around 4 percent.
The document reports external and internal economic risks. The external risk is associated with tepid global economy recovery which will affect the fiscal situation in the short term. The internal risk is associated with weak domestic recovery. Under the emerging situation, these economic risks will affect exports and imports which, in turn, will slow down the economic growth.
In the first 11 months of FY 2020, imports declined by around 19 percent in dollar terms, a welcome development according to policymakers who are of the view that the curtailment of trade deficit will be a prelude to macroeconomic stabilisation. On the other hand, a palpable reduction in imports is a reflection also of low GDP growth in Pakistan. The current negative estimates of GDP of 0.4 percent will further deteriorate since the Large Scale Manufacturing Index turned out to be – 9.0 percent in the first 10 months of FY 2020.
In FY 2021, policy makers are hoping that the construction sub-sector will perform in a stellar manner since it has many forward and backward linkages. The government has already announced (in April) a package to jump start this sector. Given the current situation, it is likely that the sector will perform at a moderate pace which is a positive element from the growth perspective.
This year’s budget is the second in a row for an elected government where the economy is facing slumpflation.
Policymakers are also contemplating revisiting the National Finance Commission (NFC) award. They are of the view that the share of the provinces in the divisible pool has become excessive. If the revenue target is not achieved in FY 2021, the Punjab will be affected the most since it depends heavily on the federal divisible pool to meet its current spending as well as its development expenditure.
In line with fiscal adjustment and to restore the Extended Fund Facility (EFF) of the IMF, the government hasn’t raised the salaries of public servants in this budget. Since this announcement, protests have been staged across certain ranks of federal and provincial governments. If the government still doesn’t raise the salaries, it will affect the economic growth negatively since the share of government services in the GDP will not grow much and austerity will dampen it further.
Similarly, there is a downward revision of 18 percent in the national Public Sector Development Programme (PSDP) from the previous year’s budgeted allocation. As a result, development expenditure/GDP ratio is targeted around 3 percent in FY 2021 and it will remain the same even in medium term budgetary framework. This downward revision will decrease public investment in the economy at a time when it is sorely needed. This reduction in public investment for economic infrastructure will affect the GDP growth negatively.
The budget document suggests that there is a 40 percent reduction in the allocation for power and petroleum subsidies in particular and 23 percent reduction in overall subsidy in general. On this basis, it is expected that private consumption will be affected and contribute negatively to GDP growth.
Briefly, this year’s budget is the second in a row for an elected government where the economy is facing slumpflation. Under the current uncertain environment, the aggregate demand is quite weak. The ‘stabilisation’ budget will cause the GDP growth to decelerate. In order to avoid this situation, the government will have to shun austerity. Let us see how the government responds to the need over the coming year.