InternationalVolume 13 Issue # 14

Fiscal deficit the culprit

The current account deficit is getting out of control. Most experts spend their energy on finding out how to arrange external financing to fund this deficit and how to reduce this deficit through monetary tightening and exchange rate adjustment.

We are faced with the dilemma of a twin deficit. Time and again, higher fiscal deficit has led to high current account deficit, and vice versa. Thus, to curtail current account deficit, the fiscal house has to be first put in order. And that is a tough decision to take, especially when the government is getting close to the elections.

The solution lies in overcoming the challenge of fiscal deficit. It is by rationalizing the fiscal situation that we control external imbalances. It is relevant to note here that that during the tenure of the present PML-N government, the fiscal revenues have increased from 13.3 percent of GDP in FY2013 to 15.5 percent in FY2017. That is primarily attributed to growth in tax revenues, from 9.3 percent of GDP in FY2013 to 11.6 percent in FY2017. But there is not much about non-tax revenues; privatization, coalition support fund and other non-tax revenue information is hard to come by. On the expenditure side, the control is visible. Spending equated to 21.5 percent of GDP in FY2013 and stood at 21.3 percent in FY2017. The fiscal deficit was lowest in FY2016 at 4.6 percent, primarily due to restricting expenditures to 19.9 percent while the revenues were growing.

But in FY2017, the revenue growth slowed down. In this situation, tough tax reforms are required to further push up the revenues, which is a difficult proposition in months close to the elections. Concurrently, curtailment of expenditure, mainly development, is a difficult proposition. This implies that the fiscal deficit will be higher close to elections. That happened during FY2009-13, when the deficit increased from an average of 6 percent of GDP (FY2009-11) to 7.5 percent (FY2012-13). It happened earlier as well in FY2004-08 when deficit increased from an average of 3.0 percent of GDP (FY2004-06) to 5.7 percent of GDP (FY2007-08).

History seems to be repeating itself in FY2014-18 as the deficit increased from an average of 5.2 percent of GDP (FY2014-16) to 5.8 percent in FY2017. Now it may cross 6 percent in FY2018. This growing fiscal deficit is the main culprit behind the widening current account deficit. The question is: What can the government do to control the fiscal deficit? The revenues are growing; but the problem is that half of the revenues are going to the provinces after the seventh NFC awards. Provinces have no political and economic incentive or compulsion to curtail their spending while they lack incentive to raise tax revenues that fall in their domain.

Prior to the seventh NFC award, on average, 62 percent of revenues (FY2004-10) were at the disposal of federal government – a figure that has since come down to 50 percent (FY2011-17). The accumulation of deficit has resulted in growing the debt-servicing cost over the period of time. This means the federal government has lost control over expenditure.

The debt-servicing cost, on an average, was 3.8 percent of GDP (FY2004-10) prior to the seventh NFC award but it has now increased to 4.4 percent of GDP (FY2011-17). With the growth in both external and domestic debt, along with currency depreciation and a hike in domestic interest rates, the servicing cost may increase further. Federal hands are tied when it comes to controlling debt servicing. Similar is the case with defence spending and general administration expenses, although these are relatively declining in terms of GDP.

Another inflexible expenditure is government employees’ pensions (including those of military personnel), and unlike others, it is growing fast. This spending head has increased from an average of 0.5 percent of GDP in FY2004-10 to 0.7 percent of GDP in FY2011-17. The pension expenditure was the highest ever at 1 percent of GDP in FY2017. The increase in pensions of government employees amid more public servants reaching retirement stage would be a cause of concern in years to come. But this is a kind of expenditure which cannot be controlled in any way.

In these circumstances, development expenditure is the only sector the government can tinker with. The PSDP was by far the highest at 5 percent of GDP in FY2017 as compared to the average of 3.4 percent of GDP in FY2002-16. The bulk of increase in PSDP came from the provinces, which spent 2.7 percent of GDP on it in FY2017 versus an average of 1.5 percent in FY2002-16. And they may be inclined to spend more in FY18 as the provinces are sitting on an accumulated cash surplus close to the elections.

Given this, how much of the trillion-rupee federal PSDP can be trimmed? Not much in the given situation, but the next federal government ought to do so in FY19. But the main dilemma is how to curb provincial spending. Well, if IMF programme becomes a reality, the fund may come up with a contingency fund condition for the federal government from the provincial share. But it is easier said than done, considering polarized provincial political realities. Apart from development expenditure, the grants and subsidies can be thinned. The subsidies were too high in FY2010-11 when electricity-related subsidies were steep. They were reduced subsequently owing to clearance of circular debt and low oil prices.

Now oil prices are inching up again, and power capacities are adding to increased capacity charges. Besides, imported RLNG, which is more expensive than domestic gas, is increasing in the gas mix. At prevailing tariffs (both for electricity and gas), the subsidies ought to increase unless tariffs are revised up. Thus, the main fiscal challenge for the new government in FY2019 would be to cut development expenditure and raise energy prices substantially to control the fiscal deficit and, thus, curb the current account deficit. But this would be at the cost of slowing the growth process spurred by enhanced energy at affordable prices amid heightened development spending, as of now.