The federal budget for 2020-21 is set in difficult circumstances with an exceptional degree of uncertainty generated by COVID-19. The economy was already reeling under the sharp slowdown brought on by the macroeconomic adjustment that began last July with accession to an IMF program when the COVID-19 pandemic hit in March 2020. The impact of the pandemic on countries is via three overlapping channels:
– The ‘external’ economic disruption caused by the pandemic (upended supply chains, halted global transportation and logistics links, interrupted flow of goods, people, investment and capital).
– The ‘internal’ economic disruption caused in response to the pandemic via lockdowns and other suppression measures (closed factories, businesses and markets).
– The public health effect (productivity loss, absenteeism, reluctant consumers, fiscal and other costs associated with COVID-19).
Collectively, this translates into collapsing growth, failing businesses, plummeting exports and massive pressure on millions of jobs. To amplify the challenges facing budget-makers, on one hand, there is the threat of food security in the wake of locust attacks, while on the other hand, there is growing aggression by India’s ruling party against Pakistan.
Weak economic growth in FY21 (possibly below two per cent), the re-appearance of inflationary pressure due to the recent rise in international oil prices, and growing debt servicing pressures translate into a constrained fiscal space. However, despite these very real constraints and trade-offs, the overriding focus of this budget should be to protect productive capacity in the economy from being shut down ‘permanently’.
The budget needs to be based on realistic revenue projections however the government announced a budget that contains no credible revenue plan yet has a sharp hike of 27% as the target for FBR taxes. Budget deficit is expected to exceed the target of 7.5 percent of GDP and may go to 9.4% of GDP owing to disruption in economic activity and increasing expenditure on public health and social safety net programs lessening the impact of COVID-19.
According to the Economic Survey 2019-20, achieving revenue targets of both tax and non-tax segments would be challenging due to disruption in economic activity. The full impact of COVID-19 on the Federal Bureau of Revenue collection is estimated at Rs899 billion for FY20.
Indirect taxes are the largest source of Pakistan’s overall revenue. They highly depend on the revival of economic and business activities and GDP growth. The next year’s target for 2.1% economic growth can be subject to slippages if demand in the global economy remains slower than anticipated. The major revenue spinner for the federal government will remain the petroleum sector. Here, the petroleum levy will see about 73% increase to Rs450 billion against Rs260 billion this year. This is the single largest item in “Rs501 billion other taxes” and the good thing is that it remains within the federal kitty unlike FBR taxes of which almost 60% go to the provinces. Deficit financing will also remain a key challenge. On top of that, the energy sector’s losses continue to be a key risk to the budget in terms of both the government’s failure to reduce losses leading to a higher circular debt and a source for tariff increase. Almost similar but of a lower magnitude are the losses of other public-sector entities, which need to be privatized or restructured.
The need for fiscal consolidation will have to be put on hold for much of FY21 until the productive sectors of the economy are out of the trouble. This means a deficit budget for yet another fiscal year. While the government should avoid a revenue enhancement focus in the budget, it can apply itself more seriously to reform of tax administration, public expenditure and debt management. Finally, in view of the large uncertainties associated with the impact on economic activity, revenue and expenditure requirement well into the next fiscal year, it would have been better for the government to present a three- or four-month ‘rolling’ budget. A large ‘COVID-19 contingency’ block allocation can also be made, with subsequent final allocations to expenditure heads as needed. This method of budgeting will allow expenditure flexibility at a time of evolving resource-availability and spending requirements caused by the COVID-19 situation.