Pakistan’s “Sugar Daddy” Budget
By Dr Ahmad Faruqui
Dansville, CA

This year’s budget is chock full of “goodies” for virtually every segment of society, strong if not incontrovertible evidence that the government plans to hold a general election next year. The bad news is that “there is no free lunch,” so someone will have to pay for all this largesse.
The budget sets a target of 7 percent growth in GDP for the next fiscal year, basing it on the average growth rate of the past three years. This target is aggressive, being two percentage points higher than what the country achieved in its entire history and one percentage point higher than what it achieved under prior military rulers.
The government plans to spend a total of Rs 1,315 billion during the next year, a rise of 19.7 percent over last year’s allocations and above the historical trend. Of this amount, the largest allocation is for development, which will receive Rs 435 billion (33 percent of total). This is up by a whopping 59.9 percent compared to last year. Debt servicing will receive Rs 295.8 billion (23 percent of total) while defense will receive Rs 250.2 billion (19 percent of total).
What exactly are the goodies being handed out? If you work for the government, you will get a 15 percent salary boost. If you are a retired government employee, your pension will rise by 15-20 percent. Teachers will get pay raises of Rs 500-1,000 per month. The minimum wage in the private sector will rise by 33 percent. The amount of tax-free annual income will rise by 50 percent for the salaried class and the highest marginal rate of taxation will be reduced by a third.
Farmers will benefit from the withdrawal of customs duty on tractors and livestock equipment. They will also get an investment of Rs 7.8 billion to increase their productivity. Sales tax will be removed from dairy products and livestock equipment.
Customs duty will be reduced for item such as automobiles and on a large variety of industrial equipment. It will be withdrawn entirely for horticulture and floriculture equipment.
To relieve shortages of key commodities, the government plans to import pulses and increase the number of utility stores. It has also allowed the import of cement and reduced its price by 25 percent. Most importantly, the budget subsidizes the prices of electricity, fertilizer and food items to the tune of Rs 80 billion. These price subsidies will lead to inefficiencies in resource allocation, by encouraging over-consumption and discouraging investment of these products. Income subsidies, which could be designed to cost the same to the exchequer, are an economically superior way of attaining the social objectives. One hopes they will be considered in the future.
What are the “baddies? Taxes will be increased on large cash withdrawals from banks and on stock trades. A new tax will be levied on real estate. All told, the government is estimating that tax revenues will rise by 18.6 percent, largely on the strength of economic growth. This growth rate is above the trend that has been observed during the past six years and may be difficult to meet. The irony is that even if it is met, total tax revenues will only add up to 10 percent of GDP, a fairly anemic amount in comparison to the 17 percent average for developing countries. What is worrisome is that this ratio has come down in Pakistan from its value in the 1980s and 1990s, when it ranged between 13-14 percent.
This budget, like all those before it, levies no taxes on farm incomes. One would have hoped that with all its talk of economic reform, a military government would be able to plug this loophole. Its inability to do so is living testimony to the power of feudal interests in the country.
A clue to the philosophy underlying the budget is found in the Economic Survey, which states: “The government is not compromising long-term development goals for the sake of fiscal prudence.” This is a surprising objective, since it contradicts one of the lessons later recounted in the same document that “there exists a strong negative relationship between fiscal deficits and economic growth.”
This “sugar daddy” budget poses five risks to the nation’s economy. Firstly, it only treats the symptoms of inflation. The government says inflation has come down from its peak value of 11.1 percent last year. Maybe it has, but the common man has not seen any improvements. And the government must concur, because it is raising wages and also subsidizing prices to the tune of 1 percent of GDP. Raising wages would raise aggregate demand, create more inflationary pressures and possibly lead to a classic wage-price spiral.
Secondly, the budget is unlikely to expand supply by stimulating investment more than consumption. And classifying privatization as foreign direct investment simply provides the illusion of capacity expansion.
Third, the budget comes on the heels of a fiscal year in which the primary balance (difference between total revenue and total expenditure net of interest) has turned negative for the first time since 1996-97. The projected budget deficit of 4.2 percent of GDP could easily grow to 5 percent since at least in one field, defense spending, one can see expenditures coming it at above budget (they were 8 percent higher this year than budgeted).
Fourthly, the budget is unlikely to contain the trade deficit, which has virtually doubled from $4.9 billion to $9.4 billion. If left unchecked, this will put pressure on the Rupee, further raising inflationary pressures. A related problem is that about 60 percent of imports consist of consumer goods.
Finally, the budget provides no details on defense spending, a silence that is justified on the grounds of national security. This overlooks the fact that neighboring India, which inherited the same bias toward cloaking defense spending from the British Raj, has dispensed with that Orwellian practice. In contrast to the single line in the Pakistan budget, it provides 80 pages for parliamentary review. The British, themselves, provide a very detailed accounting of their defense spending as do the Americans and even the Chinese!
The strong expansionary fiscal policy of the government could have been offset by a tight monetary policy but that is not the case, as noted by Agost Benard of Standard and Poor’s. Surging domestic demand is likely to re-ignite inflation. After declining for three consecutive months, the annual rate of inflation rose to 7.1 percent in May. Should the external balance deteriorate, the government would have to take drastic action in the future, not the ideal policy for an election year.

 

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Editor: Akhtar M. Faruqui
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