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 It will be withdrawn entirely for horticulture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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