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Federal budget falls short of expectations

When I sat down to write a commentary on Federal Budget FY21, I faced two odds: 1) there was not much to discuss and 2) there was no substantive explanation on how trillions of rupees additional revenue will be collected.

To begin with FY21 budget look unrealistic, the GDP growth target of 2.1% is not likely to be achieved. In the best-case scenario, the economy will stagnate. In the worst-case scenario, it may contract up to 2%. In these circumstances, the budget targeting 27% higher tax collection can be termed diabolic thinking. On top of that there is no explanation on how this target will be achieved. Does the government expect the Federal Board of Revenue (FBR) to perform a miracle next year?

Pakistan’s economy is import-dependent and it faces a shortage of foreign exchange. The next IMF Staff Report will be a much better guide to what to expect. A more fundamental concern is the rapid growth of COVID-19 infections. If the spread of the pandemic is not brought under control in the immediate future, the looming health care crisis could easily undermine the government’s economic goals for next year. The data on infections and deaths shows that the easing of the lockdown was premature. If the pandemic continues to spread at an alarming rate, businesses will eventually stop operating. This will undermine the economy’s ability to sustain livelihoods. The policy priority should be to contain the pandemic, and then revive the economy.

For FBR revenues, the government has announced an incremental target of more than one trillion rupees, but all searches are in vain for a clue as to how the targets could be met. News reports citing unnamed sources tell us that the finance adviser told the cabinet that the target will be met by resorting to measures like “petroleum development levy, profits of the State Bank of Pakistan, privatization of at least three state-owned enterprises and further expenditure cuts”.

China Overseas Ports Holding Company Pakistan, Gwadar International Terminal and many others are all tax-exempt in relation to income derived from their Gwadar port–related operations with exemptions for their contractors and sub-contractors and dividend income. It is disappointing a country that is avoiding default by the skin of its teeth continues with the wrongs that have brought it to the current state.

The supposedly ‘tax free budget’ puts inflationary concerns to rest. However, fiscal targets are elusive and would require mid-term adjustments if the government fails to get lee ways from the IMF. Moreover, potential locust outbreak poses serious threat to food security, which could lead to increase in domestic food prices, pushing inflation higher. That said, near term inflationary backdrop remains benign due to lower oil price and weak demand. In base case scenario – which assumes limited impact on domestic food prices from locust outbreak and revision in fiscal targets rather than mid-term fiscal adjustment – sees headline inflation averaging at 6.75% in FY21.

This is based on: 1) complete pass-on of increase in international oil prices reflecting the mammoth levy collection target of Rs450 billion and 2) utility rate hikes by October 2020. Lack of fiscal stimulus coupled with benign inflationary backdrop could push SBP for a balancing act, where further reduction in policy rate by 100bps could be one of the options. However, this would largely depends on how external account and domestic economic situation fare going forward.

 

Sateesh Balani, CFA Director Research, Ismail Iqbal Securities states:

Federal Budget FY21 can be termed neutral for overall market in the absence of any major triggers. Overall, this budget fell short of expectations in terms of new initiatives for reviving growth while ratified already announced incentives (amnesty for construction projects and subsidies on agriculture). Tax revenues are budget at 5trillion, with a target growth of 27% compared to provisional reading of PKR3.9 trillion in FY20. Government is once again eyeing an ambitious revenue target with very high growth without imposition of any new taxes. Thus, with projected real economic growth of only 2.1%, revenue targets seem to be quite unrealistic.

In my view government would likely revisit revenues and announce a minibudget after peak in the active cases of COVID-19 in the country. PSDP allocation has been increased by 15% compared to ongoing year expected disbursement which would likely be positive for construction-linked sectors (cements and steel). These sectors have also received marginal taxation discounts which would support margins in the near term. Other COVID-19 linked sectors (mainly health and hygiene) are also expected to be beneficiary of this budget due to taxation incentives.

PSX Stockbrokers Association states:

Members of PSX Stockbrokers Association (PSA) and other participants of Capital Market are dismayed over the neglect of the Capital Market by the Federal Government in the Federal Budget for FY21. Exorbitant rates of capital gain tax (CGT), absence of distinction between short term gains and gains on long term investments, lack of tax-incentives for companies to get listed and patent errors in relevant income tax laws (taxation of gains on disposal of securities) are not only hampering new listings but are also frustrating investors to abandon the market. Securities and Exchange Commission of Pakistan (SECP), itself an arm of the Federal Government and the Apex Regulator of the corporate world including Capital Market had many a times explained the predicament faced by the Capital Market to the FBR at the highest level. It is unusual and unfortunate that despite the Commission’s pointing out, the distortions in tax laws hurting the Capital Market and other needs of the market have not been attended to by FBR.

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