Pakistan’s fiscal policy at a crossroads

ISLAMABAD:

Fiscal policy in Pakistan usually does not strike a good balance and is rather a reckless exercise. It has long been marked by a contentious debate between austerity and stimulus measures, with the government oscillating between the two approaches, often thoughtlessly.

Thanks to this policy, the last three years have been characterized by high interest rates – the result of the State Bank of Pakistan (SBP) fight against inflation that has crushed the real estate market and increased the number of unemployed people. But why Pakistan’s interest rate has to remain as high as 22% for so long remains a burning question. The source of this problem is the extravagant spending of the government apparatus, including salaries, pensions and other privileges amounting to approximately 5 trillion rupees. This spending has historically and currently been financed by expensive debt, and interest payments alone now consume most of the federal budget.

To discourage government borrowing and push it towards austerity, SBP is increasing interest rates post-Covid. Pakistan’s Covid-19 stimulus package has been valued at Rs 1.2 trillion with an additional matching grant of Rs 100 billion for residual/emergency relief.

Since then, the SBP has been pressing ahead with its austerity agenda, setting a high interest rate to discourage further stimulus to the economy and encourage the government to cut spending.

Unfortunately, it seems that in the case of the government, such signals have not been heeded and the feedback loop appears to have been broken. The increase in spending on wages and pensions by as much as 35% in the last budget speaks for itself how seriously the government takes its austerity policy.

Moreover, it is ironic that this budget also includes proposals to increase salary costs by another 12%. This staggering increase in government spending has not been financed by increased income taxes and revenues, leading to a persistent budget deficit that necessitates further borrowing by issuing more higher-interest bonds to attract investors.

Indeed, a vicious circle has emerged in which government spending is covered by costly loans from commercial banks, resulting in persistent inflation and limited private access to capital. Currently, the only way forward for the federal government is to maintain the next cycle of external debt and investment – ​​whether it be the IMF, CPEC, SIFC or CPEC 2.0. Only then will our politics be able to fulfill its obsession with GDP growth numbers and continue to finance its political programs and pet projects.

Yet amidst all this pessimism, we can still opt for a two-tier approach to fiscal policy that advocates austerity at the center and stimulus at the periphery (provinces), combining the best of both worlds.

Savings in the center

Under the proposed model, the federal government could prioritize deficit reduction through spending cuts in the next budget and sweeping tax reforms. While the performance budgeting process has already been introduced, we must also introduce a ban on supplemental budgets; requests for ex post facto regularization of such subsidies should be penalized.

Instead of seeking more funds, government departments should explore opportunities to monetize underutilized state assets through public-private partnerships (PPP) or strategic disinvestment. This could generate revenue while maintaining essential services. One example would be to allow private companies to use unused conference/meeting rooms in ministries through an online booking system for hourly payments.

Another approach to reduce the fiscal burden at the Center could be to devolve certain ministries to the provinces as agreed in the 18th Amendment to the Constitution, but this exercise is still incomplete even after 14 years. Likewise, a regressive tax system should be replaced with a progressive one that places greater burdens on high-income earners and reduces the tax burden on low- and middle-income groups. This may include wealth taxes, taxes on luxury goods or a change in income tax thresholds.

Fiscal stimulus for provinces

Thanks to the 18th Amendment and National Finance Commission (NFC) awards, provincial governments that enjoy greater spending flexibility can prioritize infrastructure development and social programs. It is the provinces, not Islamabad’s P Block, that should plan and finance transport networks, power grids, water supply systems and irrigation infrastructure.

They can partner with the private sector to finance, build and operate profitable infrastructure projects. This reduces the initial financial burden on provincial governments and leverages the expertise of the private sector.

By identifying good projects, it will be possible to issue provincial infrastructure bonds to raise capital from domestic investors. However, this requires strong creditworthiness and a clear plan for the profits from the project.

Provinces can also offer stimulus packages by implementing targeted social safety net programs to support vulnerable populations and stimulate domestic demand. This may include direct cash transfers, food aid and health care subsidies. The federal government should refrain from funding social safety net programs such as Ehsaas or interest-free loans to marginalized populations.

However, any provincial stimulus should not promote consumption and should focus on supporting local economies, creating jobs, promoting growth and increasing revenue collection.

In short, Pakistan’s fiscal landscape requires a differentiated approach to reconcile fiscal deficit and growth targets.

A coordinated federal-provincial strategy in which the federal government implements austerity measures to address macroeconomic imbalances and provinces implement targeted fiscal stimulus to boost economic growth and job creation can help achieve the optimal balance between fiscal consolidation and expansion economic.

The author is a Cambridge graduate and works as a strategy consultant

Published in The Express Tribune, May 27^vol2024.

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