Pakistan has gone to the International Monetary Fund (IMF) 20 times before the National Finance Commission (NFC) award in 2010 and four times since 2010. Pakistan’s current financial woes did not begin with the NFC award, nor would they lessen by reducing the allocations to the provinces.

Unfortunately, we continue to debate about dividing the pie because only economic growth is a sustainable solution for reducing the debt burden.

Under the IMF’s standby agreement, Pakistan must achieve a primary budget surplus of 0.4 per cent of the GDP (or Rs401 billion).

The IMF’s January 2024 report noted, “The authorities’ strong revenue performance in the first quarter of the current fiscal year, as well as federal spending restraint, has helped to achieve a primary surplus in line with quarterly program targets.” Pakistan’s budgetary position continued to improve in the second quarter, and the primary surplus was 1.7pc, compared to the target of 0.4pc. The risk of not meeting the target has diminished significantly.

There seems to be no justification for slashing the allocations to the provinces, citing reasons which appear to be based on flawed reasoning

So, there seems to be no justification for panicking and slashing the allocations to the provinces, citing reasons which appear to be based on flawed reasoning. It is important to correctly diagnose the problem before we rush for the prescriptions.

Leaving aside the argument that an arbitrary change in the allocation to the provinces would be against the Constitution and the principles of a viable and genuine federation for a moment, I would submit that the current fiscal predicament has little to do with the NFC award. Here is why.

Federal bureaucracy

Under the 18th Amendment, many responsibilities — notably law and order, education, and health — were transferred to provinces. Still, the federal government continued to run a large bureaucracy and did not reduce its role proportionately.

Expenditure on running the federal government went up from Rs271bn in 2013-14 to Rs553bn in 2022-23, or by 104pc, when it should have gone down.

Development spending

It is alleged that the provinces went on a spending spree through public sector development programmes. The facts don’t support this contention. Overall, development spending grew at an annual average of 9.1pc for 10 years from FY14, which was in line with inflation. However, it did not grow in real (or inflation-adjusted) terms.

The crux: fiscal deficits and tax collection

The crux of the problem is the increase in the debt burden, as Pakistan’s public debt-to-GDP ratio is close to 80pc.

The fiscal deficit declined from 7.9pc in 2012 to 5.8pc in 2018, and the tax-to-GDP ratio increased from 9.2pc in 2012 to 10.8pc in 2018. In simple words, the federal government’s finances improved steadily till 2018, after the introduction of the NFC award.

The 7th NFC Award of 2010 envisaged increasing the tax-to-GDP ratio to 15pc of GDP over five years until 2014-15. The federal government’s performance improved between 2013 and 2018, but it still came nowhere close to achieving that goal.

The problem worsened after the PTI government took over in 2018. The Federal Bureau of Reserves’ tax collection barely grew between 2018 and 2020 in nominal terms and declined in real (inflation-adjusted) terms —federal government debt exploded in the last five years.

The federal government resorted to heavy borrowing after 2018 to make up for its failure to grow tax revenues and control expenditures. Its total debt shot up by 60pc to Rs39.8 trillion in just three years from FY18 to FY21.

The country went into a debt spiral after the double whammy of the global energy and Ukraine war crises in 2022 hit it. Although the public external debt grew by just 4.7pc to $99bn during 2021-23, it exploded in rupee terms by a staggering 77pc.

Due to this combination of factors (borrowings, higher interest rates, devaluation), markup payments went out of control from FY19 onwards. The Pakistan Democratic Movement government should accept some responsibility for the massive drop in the currency value because it was caused, in part, by the delay in securing the IMF agreement.

The transfers to provinces did not cause an explosion in debt servicing. From FY14 to FY23, the markup payments in the federal budget went up by 396pc to Rs5.7tr. The transfers to provinces went up by just 200pc to Rs4.2tr during this period.

The provinces’ share is just 8.3pc (6.6pc in FY14) of the total tax revenue. They could have collected more agriculture and property taxes, but these issues could not be resolved even under military dictatorships.

Would this situation change if the federal government was given responsibility for the taxation of these sectors through a constitutional amendment? Due to political expediency, the federal government failed to expand the tax net to wholesale and retail traders.

Agriculture, real estate, and wholesale/retail trade account for nearly 60pc of the economy. The federation vs the provinces debate appears to be a little redundant, given that the former failed to bring these sectors into the tax net for decades because there was never any political will to do so. Hence, the burden of indirect taxes has grown to the point where poverty is rising and the middle class is shrinking.

The government needs a debt reduction plan because trillions have been added to the debt burden during the last five years. We need a multi-pronged strategy, including debt restructuring, privatisation, and foreign investments.

Privatisation would not work in the current environment. Taking on more debt to meet the debt servicing obligations may be a bitter pill in the short term, but debt reprofiling may become unavoidable. Radical expenditure cuts and debt restructuring should help the country gain credibility with foreign governments and investors.

We must do this as Pakistan is not Egypt, and no country is going to write a $35bn cheque to bail us out.

The writer is the former head of Citigroup’s emerging markets investments and author of ‘The Gathering Storm’

Published in Dawn, The Business and Finance Weekly, March 25th, 2024