Concerns Regarding Pakistan’s Fiscal Deficit • Main features of Pakistan’s public finances and fiscal deficits: 1. Total expenditure exceeds total revenue, and the growth in expenditure is greater than that in revenue 2. Current expenditure alone exceeds total revenue 3. Development expenditure has been falling, while current expenditure has grown 4. Defence expenditure has been very high, and much higher than even development expenditure
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Concerns Regarding Pakistan’s Fiscal Deficit
• Main features of Pakistan’s public finances and fiscal deficits:
1. Total expenditure exceeds total revenue, and the growth in expenditure is greater than that in revenue
2. Current expenditure alone exceeds total revenue
3. Development expenditure has been falling, while current expenditure has grown
4. Defence expenditure has been very high, and much higher than even development expenditure
5. Interest payments, along with defence expenditure constitute more than half of annual expenditure
6. The man source of financing the fiscal deficit has been non-bank borrowing, rather than bank borrowing
7. Domestic debt is greater than foreign debt8. A substantial amount of financing of the debt is
done by domestic sources rather than foreign resources
9. The fiscal deficit has been around 8% of GDP for much of the 1980’s.
Concerns Regarding Pakistan’s Fiscal Deficit
• Trends since the 1980’s:1. Total revenue has remained more or less the
same in 22 years, despite reforms of different sorts.
2. Although total expenditure has fallen, current expenditure has actually risen in the 1990’s, and has not fallen significantly since 1999.
3. Debt servicing has increased over time. The highest proportion ever (8.3% of GDP) was paid out in 1999/2000
4. Defence expenditure has fallen over time (but there have been changes in the composition of what constitutes defence expenditure)
5. Development expenditure has fallen very dramatically from a high of 9.3% in 1980/81 to a mere 2.1% in 2001
6. The budget deficit has been brought down to the early 1980 levels.
Concerns Regarding Pakistan’s Fiscal Deficit
• Complete agreement that the federal budget is the most important threat facing Pakistan
• Fiscal policy has been a ‘failure’, and threatens:– Price stability– BOP– Govt. investment in economic and social
infrastructure– Future growth prospects
Concerns Regarding Pakistan’s Fiscal Deficit
• The IMF holds the budget deficit responsible for the following in Pakistan:– Growing inflation– Crowding out of private investment– Falling growth rate– Deterioration of the current account deficit
• Does empirical evidence support their claims? Table 11.2
Concerns Regarding Pakistan’s Fiscal Deficit
• Pakistan experienced very high growth rates compared to other developing countries, and averaged over 6.5% p.a. during the 80’s
• Inflation averaged at around 7%, when it should have been around 50%, given the high and unsustainable deficit– 90’s: inflation increased, whereas the deficit
fell
Concerns Regarding Pakistan’s Fiscal Deficit• Crowding out: what does the theory say?
– Pakistan’s private sector expanded at a rate of 15% p.a. during the 1980’s
• Despite the drastic fiscal cuts since the 1988 reforms dictated by the IMF, – Real per capita GDP rose by 10.4% b/w 1988 – 92– Merchandise exports expanded by a volume of 14%
So does the budget deficit really matter in the case of Pakistan?
IMF/WB’s view about the deficit
‘the macro consequences of fiscal deficits in Pakistan have been quite dissimilar from those in other developing countries with fiscal deficits of comparable magnitude. Specifically, Pakistan has experienced neither hyperinflation nor debt rescheduling…Growth has remained quite strong through the last two decades, inflation has not been high, and the CAD has averaged around 2% of GNP, remaining financeable and not posing debt servicing problems for the country.’
IMF/WB’s view about the deficit
• These institutions admit that despite the presence of fiscal deficits that are very high by international standards, there is no evidence in Pakistan of the chronic acute macroeconomic crises– Economic growth has been robust– Real GNP per capita has shown an increase– Public and private investment seem to be
positively correlated
IMF/WB’s view about the deficit
• A study by the IMF concluded that:– Aggregate government investment had a
significant positive impact on private investment
– The crowding out effect was not strong enough to balance the crowding-in during 1972 – 88
– Govt. investment in infrastructure was the most important determinant of private investment in the period covered
IMF/WB’s view about the deficit
• Why has Pakistan’s budget deficit behaved differently?– The budget deficit was not monetized, so
inflation remained low– The govt. was able to borrow, both
domestically and externally, at rates well below the marginal cost of funds
Author’s view about the deficit• Keynsian interpretation seems closer to reality in
the context of Pakistan– given the less than full capacity of the economy, public
spending causes an increase in AD, and subsequently, growth.
• Since Pakistan’s GDP is estimated to be under-reported by about 40%, the size of the deficit is much less than the official figure and therefore, may be sustainable
• The budget deficit is not the real culprit after all!
Re-examining Critical Concerns
• The real concern should be regarding the issue of spending and redistribution– What use is being made of public money?– Who is funding govt. expenditure, i.e. who is being
taxed?– How is public expenditure managed?
• The contrast in the pattern of development and defence expenditures should be the real concern. And why did defence spending increase with the advent of democracy?
Re-examining Critical Concerns
• Even after the advent of democracy in 1988, defence spending remained greater than development spending. Why??– During military rule, not only was the military making
direct use of the defence budget, but also, due to its status as ‘the govt.’, it acquired a large share in the civilian side of the economy
– Although the military was not in government in the post martial law period, it was still in power; it continued to play a policing role
The Domestic and Foreign Debt Crises
• Debt Reduction and Management Committee set up in Jan 2000.
• Pakistan faced a serious crisis on both fronts: domestic and foreign.
• Debt Reduction and Management Strategy (DRMS) laid down the causes for the excessive debt that had been accumulated, and the possibilities and solutions to alleviating this debt
• Considerable pressure has been lifted off the debt crisis, largely attributable to external factors
The Domestic and Foreign Debt Crises
• Reasons for the high debt:– Large and persistent fiscal and current account balance of
deficits– Imprudent use of borrowed resources
• Wasteful govt. spending• Borrowing for non-development purposed• Undertaking low economic priority development projects• Poor implementation of foreign aided projects
– Stagnant and declining real govt. revenues and exports => weak debt carrying capacity
– Rising real cost of govt. borrowing, both domestic and foreign.
The Domestic and Foreign Debt Crises• The domestic and foreign debt need to be
analyzed separately, since they have a different nature and impact on the economy
• All indicators of debt have improved since 2002; 9/11 has been a blessing in disguise for Pakistan
• This debt problem emerged in the 1980’s, when Gen. Zia-ul Haq’s govt. was spending far more money than it was receiving. – Nominal public debt grew from around Rs. 155
billion to 802 billion during the 90’s, and further to Rs. 3200 billion by 2000
The Domestic and Foreign Debt Crises• 1996 – 99: public debt grew very sharply.
– 80’s: although debts and deficits were high, growth was quite impressive and development spending was also high
– Post ’96: growth rates fell sharply and revenue generated by the govt. also declined => debt burden increased by manifolds.
– Interested rates jumped from negligible levels in the 80’s to very high rates in the 96 – 99 period (wrong sequencing of the structural adjustment reforms)
– Constant devaluation of the rupee, making it more expensive to service foreign debt in rupee terms
• Paid back in terms of interest alone much more than it borrowed
The Domestic and Foreign Debt Crises
• Other factors responsible for the high debt:– Low savings rate compared to other countries– Lack of fiscal discipline, with tax revenues declining– Political interference and weak institutions– Schemes such as the yellow-cab scheme, for which the
public sector had to bear large losses– Decline in capital inflows during the 90’s– Sequencing of reforms– Lower ceiling on bank borrowing for budgetary support,
forcing govt.’s to shift to non-bank borrowing– Capital flight
The Domestic and Foreign Debt Crises
• The current reprieve that the economy has been given has come due to external factors which proved to be fortunate for Pakistan, and not due to the strategy proposed by the DRMS– Debt rescheduling worth $12.5 billion, along
