The Big Squeeze

Spearhead Opinion – 08.02.2019

By Farrukh Karamat
Senior Research Coordinator, Spearhead Research

The Federal Government is expected to pay around Rs.3.6 Trillion on account of defence spending and debt servicing that is equal to 68.2 per cent of the FY2019’s revised budget. After meeting these obligations the net federal revenues for FY2019 is a negative Rs.632 Billion. With the Federal government’s total gross revenues estimated at Rs.5.5 Trillion, the provinces would receive Rs.2.581 Trillion as their share in the federal divisible pool, leaving net Federal revenues at Rs.3 Trillion, out of which debt and defence spending is expected to be Rs.3.62 Trillion, or 121 per cent of the net federal revenues, leaving no option but to borrow to pay salaries, pensions, run hospitals, schools and build roads. In effect every Rupee of the Center’s development spending is borrowed through different sources.

  • Against the stated Defence budget of Rs.1.1 Trillion, the Finance ministry has confirmed that by the end of FY2019, a sum of Rs.1.676 Trillion would be spent on defence, which is equal to 31.5 per cent of the Federal budget – the second largest charge after debt servicing. The Rs.1.676 Trillion defence expenditures include pensions, strategic nature expenses and special military packages.
  • Against Rs.1.842 Trillion budgeted for debt servicing, the debt servicing is expected to consume around Rs.1.95 Trillion, or 36.6 per cent, of the total budget. The recent decision of the Central Bank to raise interest rates has put an additional burden of roughly Rs.500 Billion due to high cost of borrowing.

As a result the cumulative spending on the debt and defence is projected at Rs.3.621 Trillion, or 68.2 per cent, of the budget, leaving little leeway for the government to manage the budget.

Questions have been raised from different quarters over the fiscal and budgetary deficits and the economic fundamentals over the next two years. Based on the poor fundamentals Standard & Poor’s (S&P) has downgraded Pakistan’s long-term credit rating to ‘B-Negative’ from ‘B’, as the government continues to struggle with its structural reform agenda. As per S&P: “Pakistan’s economic outlook, as well as its external position, have deteriorated well beyond …. previous expectations…The prospects for a rapid recovery in fiscal and external settings are now diminished.”

It is expected that modest growth prospects and limited reserve buffers will continue to pose challenges for the country’s external position, even though the government receives financial assistance and aid from various ‘friendly countries’ and as negotia­tions with the International Monetary Fund (IMF) continue to be delayed. In the short-term, S&P affirmed Pakistan’s ‘B’ rating on the basis of expectations that the country would secure sufficient funding to meet its external obligations in the next one year. However, S&P has revised the GDP growth rates to around 4.8 per cent in FY2019 (FY2018: 5.8 per cent); and 3.5 per cent for 2020 and 2021; and 3.3 per cent by 2022. A drastic cut for a country that has a burgeoning population growth and needs 7.5 per cent economic growth for sustainable economic development.

While Pakistan has managed to secure financial aid from bilateral partners to address the immediate external financing needs, the fiscal and external imbalances remain elevated and the protracted negotiations with the IMF are delaying much needed structural reforms. With limited growth drivers and a slowdown in the China-Pakistan Economic Corridor (CPEC) investment Pakistan will continue to face challenges in the short-to-medium term. The Government has effectively failed to introduce timely fiscal measures sufficient to bring about a substantial improvement in the general government deficit. The second mini-budget presented in January would be marginally supportive of the economy, but is unlikely to have a significant impact on fiscal imbalances.

The pressure on external accounts is expected to increase further in 2019 and general government debt is forecast to increase to 70.2 per cent of GDP by the end of FY2022 and the interest-servicing burden will remain elevated, at an average of 32.4 per cent of revenues. S&P expects the current account deficit to marginally decline over the next two years, if energy prices continue to fall and the economic slowdown continues, but the external financing and indebtedness metrics would remain stressed, and the economy’s gross external financing needs relative to its current account receipts will rise to 151.1 per cent at the end of FY2019 (FY2018: 131 per cent). It is projected that the country’s narrow net external debt would rise to more than 170 per cent of current account receipts from just below 140 per cent in FY2018.

In the wake of these constraints the Government continues to delay the much needed structural reforms by focusing on an anti-corruption drive, with State Ministers openly accusing opposition members who are or are expected to come under trial from the National Accountability Bureau (NAB). As a consequence the parallel economy that was the driving force behind the growth in the past has dried up and the general economic activity has started to decline. In addition, the falling Rupee, rising interest rates and imposition of regulatory duties is constricting economic growth and inflation as at January 2019 was reported at 7.2 per cent. This is reducing the disposable income of the people with resultant expense reduction which is impacting the retail and service economy. The current account deficit, the trade deficit, and falling FDI are major impediments for growth in the future.

In this scenario fiscal management to tide over the year is not a viable solution and should not be the main focus of the Government. Real fiscal and structural reforms based on a long-term outlook are urgently needed to jump start the manufacturing sector and channelize the funds towards productive use. The IMF negotiations should be speeded up and concluded to commence the reform agenda. The promise of potential investment from KSA and UAE are good starting points if these investments materialize, but China remains the single largest investor in Pakistan. The Government has been in power for almost six months now and it is high time that they acquire a focus for investors, instead of scrambling from pillar to post, to provide the impetus and direction to the Pakistan economy for growth. Reliance on recovery of so called looted funds is a credible measure but that should not take precedence over real economic and fiscal reforms. The Big Squeeze based on extracting maximum from the population in the absence of real reforms will land us in greater problems than in the past.