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Tuesday, January 26, 2010 Add to Clippings Print Story

Analysing budgetary risks

Dr Ashfaque H Khan In my articles of June 9, 16, at the time of the presentation of the federal budget for 2009-10, I had clearly warned that banking on uncertain external inflows to finance a large fiscal deficit was highly risky. In particular, the heavy reliance on the pledges of the Friends of Democratic Pakistan (FODP) and grants for the internally displaced persons to finance the fiscal deficit was a source of anxiety and a major risk to Budget 2010. At the end of the first half of the current fiscal year (2009-10), my position has been vindicated. Budget 2009-10 is facing major risks on multiple fronts. The purpose of this article is to analyse various risks associated with Budget 2009-10. Let me analyse first the revenue side. The Federal Board of Revenue had the collection target of Rs1,380 billion in 2009-10. The target was further enhanced in consultation with the IMF to Rs1,396 billion, as against the previous year's collection of Rs1,157 billion an increase of 19.3 or 20.7 per cent. The revenue target was grossly over-optimistic as the FBR was asked to raise its tax-to-GDP ratio from 8.8 to 9.3 per cent in a depressed economic environment. The Pakistani team which negotiated with the IMF did not do its job properly. The IMF, for its part, was unreasonable in forcing the government to accept the target. During the first half of the current fiscal year (July-December), the FBR has collected Rs581 billion, which is only 4.9 per cent higher than the comparable period of last year. In order to achieve the revenue target (Rs1,380 billion), the FBR had to collect Rs799 billion, or a 32.5 per cent growth in the remaining half of the current fiscal year. If one compares it with the revised target, the task becomes even harder. The FBR needs to collect Rs815 billion in the second half with a monthly average of Rs136 billion, or a growth of 35.2 per cent. Can this revenue target be achieved? This appears to be a daunting task even in the midst of rising oil and electricity prices and a depreciating currency. The chairman of the FBR appears to be confident, at least in the press, about achieving the target. While I have full sympathy with the chairman, my estimate suggests that the collection would be in the range of Rs1,300-1,330 billion. To achieve even this target, the FBR's tax collection must grow in the range of 19-24 per cent during the second half of the year. Let me turn to the fiscal deficit and its financing. The underlying budget deficit for 2009-10 was 3.4 per cent of the GDP; a cushion of another 1.2 per cent was given against the Tokyo pledges, and yet another cushion was provided on account of expenditures on the IDPs. Thus, the overall fiscal deficit was targeted at 4.9 per cent of GDP, or Rs721 billion. The financing of Rs721 billion was to come from external sources (Rs267 billion), domestic sources (Rs350 billion) and grants (Rs104 billion). Massive slippages on the financing side are emerging, giving rise to many risks to the budget. Firstly, on the grant side, Rs47 billion and Rs49 billion were to come from the Tokyo pledges and for the IDPs, respectively. Only Rs20 billion has so far been received for the IDPs and nothing came through the Tokyo pledges. Secondly, under external financing, Rs161 billion was to come from the Tokyo pledges but only Rs25 billion has so far been received, thereby creating a financing risk to the deficit. Thirdly, Rs112 billion or $1350 million was to come from the United States under the Coalition Support Fund (CSF). This amount has not yet been released by the United States, thereby creating a shortfall to the extent in total revenue with its implication to budget deficit and its financing. If there is a slippage the in budget deficit, the United States government will be equally responsible. Thus, total inflows worth Rs320 billion (CSF: Rs112 billion; FODP: Rs136 billion; grants: Rs20 billion) has become uncertain and created serious risks to the budget and its financing. What are the options available with the government to achieve budgetary targets? Firstly, the FBR target is highly ambitious and is not expected to materialise. If the CSF is not available it would further reduce the revenue. Slippages in FBR's revenue and non-availability of the CSF would substantially reduce the overall revenue and if expenditure remains on the target, it would widen the overall budget deficit.

Secondly, the financing of fiscal deficit has become a major source of concern because of the heavy reliance of the government on uncertain external flows. Any further widening of the fiscal deficit would create serious budgetary and financing problems for the government. There are two options available with the government. Firstly, an increase in tax rates for generation of more revenue. This option is not advisable, because this could cause more harm than benefit. Raising tax rates in an environment of depressed economic activity would be bad economic policy, and we must avoid taxing such a route. The other option is to cut inflated development programme. The government has already taken this route and released only 30 percent of the development budget in the first half of the year. This is the right approach and it must be followed in the second half as well. Funds may be released for projects which are near completion. New projects must not receive funding and slow-moving projects must be shelved for a year or two. Substantial savings can come from the Benazir Income Support Programme as Rs70 billion cannot be spent in a year. Some rationalisation of current expenditure will be required. There is a lesson which needs to be learnt. Never prepare a budget on uncertain external flows and listen to people who have been dealing with such issues. There is also a need to strengthen the economic team which can negotiate with the IMF in a more professional manner.

The writer is director general and dean at NUST Business School, Islamabad. Email: ahkhan@nims.edu.pk

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