NationalVOLUME 15 ISSUE # 14

Fiscal deficit’s downward trend

The latest figures for the first half of fiscal 2019-20 show that fiscal consolidation continues apace. Total fiscal revenue (as percentage of GDP) touched a two-decade high – as non-tax sources turned out to be major contributors to the final account. However, the expenditure side too showed a rising trend, coming in at 20-year high. Not surprisingly, debt servicing remained the biggest expenditure head.

Expenditure grew by 18.8 percent, largely in line with tax revenue growth at 18.4 percent. Debt servicing remains the biggest headache, mounting mainly due to high interest rates. Fortunately, achieving primary fiscal surplus (0.7 percent of GDP in 1HFY20) means that debt accumulation is slowing down. Once the discount rate begins to climb down, the consolidated fiscal deficit will decline as well. However, there is a caveat here: higher growth in non-tax revenues is partly thanks to higher interest rates.

The total fiscal deficit in 1HFY20 stood at Rs 995 billion, which at 2.3 percent of GDP is a four-year low. The fiscal deficit in 2QFY20 stood at 1.6 percent, whereas it was 0.7 percent of GDP in 1QFY20. The slippage may increase in the third and fourth quarter. Federal tax revenues grew by 18.8 percent to Rs 2.25 trillion while provincial tax revenues increased by 14.2 percent to Rs 214 billion. The slower growth rate in the provincial number is partly explained by lack of incentives for the provinces to enhance their collection.

The provinces receive about three-fifth of FBR revenues, while debt and defense liabilities remain federal subjects. This means that efforts at the federal level to maximize FBR revenues – and contain deficit – become diluted as the major share is taken by the provinces. On the other hand, non-tax and tax revenues are more beneficial for the federal government. The revenues are not shared with the provinces and all proceeds can go toward curbing the consolidated deficit.

The central bank passed Rs 427 billion as surplus profits to the government, which is 6.7 times last year. In case of other tax revenues (those not shared with the provinces), the government collected Rs 157 billion in 1HFY20 – up by 58 percent. The importance of non-shared revenues is profound in terms of deficit reduction. The debt servicing cost in terms of net federal fiscal revenue was 95 percent last year (1HFY19). During the first six months of the current year, it was reduced to 78 percent. This is despite the fact that debt servicing increased by 46 percent to Rs1.28 trillion in 1HFY20. Had the non-FBR federal revenues growth been in line with last year, the government would have acquired more debt to pay the existing debt.

According to experts, the federal fiscal arrangement created in the aftermath of the 18th amendment and 7th NFC award has led to greater focus on non-FBR federal revenues. That is why in the recent IMF review, the ministry of finance tried to get higher revenues from petroleum levy (PL). The reason for showing primary surplus in 1HFY20 is due to over 3 times spike in non-tax revenues. The situation will remain easy as long as higher surplus profits from the SBP continue to come in. Telecos dues are still pending, while privatization proceeds are imperative for attaining the primary fiscal deficit target for the full year. In other words, about 58 percent of FBR revenues increase will not go towards efforts to reduce the consolidated fiscal deficit. On the flipside, 100 percent of PL, SBP profits, dividends, privatization, PTA profits contribute to deficit reduction.

In the long run, there is a need to find more sustainable ways of increasing non-FBR revenues for broader fiscal consolidation. Once the interest rates come down, fiscal consolidation would be more visible. The fundamental advantage of tight monetary policy on the fiscal side is that the government is on its toes to reduce non-debt expenditure and is focused on revenues. Without higher rates, the sense of urgency would not be possible.

As it is, FBR revenues are up by 17 percent to Rs2.1 trillion; but have fallen short of the revised target. At best, the government can fetch Rs 4.7 to 4.8 trillion in the full year. However, given the economic slowdown and import compression, performance in the first half is not dismal. Direct taxes are up by 17 percent to Rs 784 billion in 1HFY20 – but appear to be tapering off as growth in the first quarter was 21 percent. Sales tax collection increased by 24 percent to Rs 859 billion – which is much better than the first quarter growth of 13 percent.

It is relevant to note here that fiscal expenditure increased by 26 percent to Rs 4.23 trillion. Taking out debt servicing, expenditure growth falls to 19 percent – which is still too high. Current expenditure increased by 25 percent to Rs 3.36 billion whereas defense expenditure increased by 10 percent to Rs 530 billion. Development expenditure picked pace too, growing by 28 percent to come in at Rs 473 billion. All said, the government can derive satisfaction from the fact that as a percentage of GDP, the deficit in 1HFY20 decreased to 2.3 percent as compared to 2.7 percent during the same period last year.