Every year in June, the economy becomes the talk of the town and numbers start raining on television and in newspapers; welcome to budget season!

For the uninitiated, or those not too comfortable with numbers, it becomes quite difficult to make sense of all the information flying about. So if you are one of those people who have a hard time grasping the terminologies being thrown around, this article can help you understand how to read and comprehend the annual budget.

Just like a household plans how it will distribute its income to cover various fixed and variable expenses — such as utilities, fuel, rent etc. — countries also prepare annual budgets to decide how much to spend in a year, and on what.

Revenue

When Pakistan releases its annual budget today, the two main numbers to look at would be how much is the country expecting to make in the year (Revenue) and what are its total expenses (Total Expenditure or Budget Outlay).

The main source of revenue for the government is tax collection, which makes the Federal Board of Revenue’s (FBR) tax target one of the most important figures in the budget because that is the single most important determiner of how much money Pakistan is looking to collect in the year. So, if the FBR tax target is much higher than the previous year, it means the government is looking to impose more direct and/or indirect taxes in the upcoming year.

Expenditure

As far as spending is concerned, one figure to look at would be Debt Servicing/Payments — which in recent years has been the single largest head in the expenses column. Last year, this stood at 36 per cent of Pakistan’s total expenditure. Add Defence Services and Pension to it and these three heads combined account for roughly 60 per cent of the country’s total expenditure.

In an ideal situation, one of the biggest expenses should be the Public Sector Develo­pment Programme (PSDP) — i.e. planned expenditure on development projects such as roads, infrastructure, hospitals, schools, vocational centres etc. This is the government’s investment to uplift the people’s quality of life and, eventually, the economy as a whole.

Another item in the expenses column that is seen as an indication of where the government wants money to flow is Subsidies, i.e. how much the government is paying businesses/industries to keep prices of certain products low.

Usually, taxes and subsidies are tools the government uses to create an incentive structure so that more capital flows, from sectors it is taxing to sectors it is subsidising. Naturally, people would want to invest more in sectors that become lucrative due to subsidies and avoid those that are facing higher taxes. Creating this incentive structure is an important role of the annual budget.

Budget deficit: Why it’s bad for Pakistan

For several years now, Pakistan has been issuing a deficit budget — which means that the country’s expenditure outstrips its revenue, which in turn means that the government plugs this gap through foreign loans (such as the IMF programme and other bilateral or multilateral sources), domestic loans (National Savings Schemes, bonds and commercial banks), selling/privatising national assets or increasing taxes and tariffs.

For a household or an individual, running a deficit is an alarming situation, signalling an immediate need to cut down spending or generate extra income. In macroeconomics, however, a deficit budget may not always be a cause for concern. In fact, it can be part of the government’s strategy to stimulate the economy in order to spur growth by spending on projects and certain businesses and sectors, or what economists refer to as an expansionary fiscal policy, during an economic slowdown.

But Pakistan’s deficit should not be seen in that light because, in recent years, the biggest chunk of government expenditure is not on spending to spur growth but is a result of efforts to plug past deficits (debt servicing) — the trappings of a vicious cycle.

And this brings us to another crucial number to watch out for: How the government plans to finance the deficit. Opting for more loans, particularly foreign loans, will result in debt servicing costs next year, which will have an impact on next year’s deficit. Pakistan, which already pays a huge amount in debt interest payments, financing the deficit through loans means acquiring new debt to pay for past debt.

Increasing taxes and tariffs to finance the deficit has its own costs as it will hurt the citizenry which is already paying its share of taxes and will squeeze their purchasing power which in turn hampers the economy’s growth. Borrowing from local commercial banks is an issue because after lending to the government, these banks have little liquidity left to fund the private sector — a problem known as ‘crowding out’. Long-term budget deficits, particularly those that don’t occur because of targeted government spending to boost growth — as is the case in Pakistan — are damaging for economic stability and growth.

Calculating the budget deficit

While this is a pretty straightforward calculation otherwise (just subtract expenditure from the revenue), in Pakistan’s case there is an additional step involved.

Our deficit is more pronounced than what appears to the eye because the federal government transfers a large part of its revenue to the provinces as part of a constitutional ar­­ra­n­gement known as the National Finance Com­m­­ission (NFC) Award. Since this transfer to the provinces is not actually an expense, it does not show up in the expenditure column. But it does eat up the federal government’s re­­venue, which is why the Net Revenue (after sub­­tracting the provincial transfer from total revenue) is the number you should be looking at.

However, the provinces do not have the capacity to spend the entire amount transferred by the federal government and therefore the budget accounts for that in the form of a Provincial Surplus allocation. Simply put, this is the amount expected to be left unused by the provinces and is added back to the federal government resources.

Therefore, the budget deficit is calculated as: Gross Revenue (minus) Transfer to Provin­ces (plus) Provincial Surplus (minus) Total Expenditure.

Published in Dawn, June 10th, 2022