REPORTING to parliament the major violations of the Fiscal Responsibility and Debt Limitation Act 2005 during the last three years, the ministry of finance has raised a red flag over faltering revenues and drying up  external inflows against rising spending needs that pose serious risk to external account sustainability.

A daunting fiscal challenge lies ahead, particularly after the recent devastating floods that have left the policy makers with little options to undertake crucial fiscal adjustments A balancing act lies ahead for fiscal policy in creating fiscal space while meeting new demands on the budget, says the Fiscal Policy Statement 2010-11 prepared by the Debt Policy Coordination Office (DPCO)

The focus for creating fiscal space should be on revenue mobilisation, efficiency and reprioritisation of public expenditure, as well as reforms which could help limit future fiscal pressures.

The fiscal policy statement has come at a time when the total public debt at the end of September 2010 has reached its highest ever Rs9.473 trillion mark, with about Rs500 billion debt accruing just as a result of currency depreciation.

The fiscal performance has remained very weak. “While the reported fiscal deficit per se has consistently breached the target, it does not fully reflect the costs associated with quasi fiscal activities such as commodity operations and unrecognised portions of subsidies, especially relating to power sector funded directly by public sector entities borrowing from banks.”

Also haphazardly designed measures to provide ‘relief’ eventually cause more ‘pain’ for the public in general as the fiscal policy becomes subservient to political exigencies as government extends subsidies.

Fiscal slippages also continued on account of current expenditure and lower revenue collection. Security spending, including IDP related expenditure, coupled with electricity subsidies were the highlighting factors during fiscal 2009 and 2010 while efforts to reform the existing revenue structure by increasing tax net, reducing exemptions and eliminating zero ratings had not yet succeeded.

Economic growth remained subdued in fiscal 2010 owing to a multitude of factors like widening of fiscal deficit, double digit inflation — for a third year running — high interest rates, low level of non-debt creating foreign exchange inflows and a rising debt burden as the government kept on curtailing development spending and compromising better living standards for the teeming millions.

“The structural weaknesses have lead to sizable, and at times unsustainable, budget deficits posing risks to fiscal solvency”.

The statement reported that binding legal requirement to reduce the revenue deficit to nil in five years since 2005 had been violated as revenue deficit approximated to Rs308 billion or 2.1 per cent of GDP. Another requirement that public debt should not exceed 60 per cent of GDP had also been breached as the total debt stood at 60.6 per cent of GDP at the end of June 2010.

Also, the legal requirement that the total public debt should be reduced by 2.5 per cent of GDP every year had also been ignored as 0.7 percentage points of GDP were added to the total debt stock during fiscal year 2009-10. The government also failed to abide by the law not to issue new guarantees beyond two per cent of GDP in any financial year as it provided or rolled over guarantees worth about 2.2 per cent of GDP during last fiscal year in addition to issuing 0.5 per cent of GDP worth of letters of comfort for commodity operations.

The policy statement said the soundness of Pakistan’s debt position, measured by various sustainability ratios, while deteriorating slightly from the previous fiscal year, remains higher than the internationally acceptable threshold.

In the last three fiscal years, the fiscal deficit has averaged 6.4 per cent of GDP. The decline in the national savings and investments is, “jeopardising economic and social stability,”. the statement said. Fiscal year 2009-10 was the third consecutive year of double digit inflation and higher fiscal deficits have contributed towards this. The energy shortages and security concerns have considerably reduced the non-debt creating external flows; fortunately a sharp narrowing of current account deficit has deferred the pressure on balance of payment in the presence of higher deficits in the recent months.

Increase in commodity prices in the wake of global economic recovery and drying up of external finance account flows will pose serious risk to external account sustainability. With the international price of oil rising, it is imperative that the government maintains its market-based pricing policy for POL products and avoids additional strains on limited budgetary resources. Government should take corrective measures to augment the foreign currency inflows.

Critical of the current move to cut expenditures, the DPCO calles upon the policy makers and the parliament to “explore opportunities for augmenting the resource envelop rather than cutting expenses”. At the same time, expenditure should be rationalised and non-productive outlays should be curtailed that will bring improvement in the national investment climate, saving incentives and opportunities, and competitiveness of the real economy.

It has also called for the enhancement of the pool of national savings, allowing for required investments to be made without putting the government’s fiscal position at risk. Positive real interest rates are essential as they will attract substantial funds currently outside the purview of the official monetary system. Moreover, budgetary borrowing options need to be revisited to ensure that financing of future deficits does not dilute monetary policy’s efforts to keep money supply in check and tackle inflation.

The revenue collection in real terms has been weak at best i.e. a rise of two per cent in the fiscal year 2009-10. Furthermore, real growth of 7.9 per cent  in expenditure has been higher than the real growth of revenues..

The widening gap between growth of revenues and expenditure has led to escalating revenue deficit to the tune of 2.1 per cent of GDP. The primary balance also remains in deficit by two per cent of GDP.

A significant growth in real revenues is essential to maintain fiscal sustainability, and to finance the government’s economic plans.

Going forward, there is need to strike a balance in development expenditure on infrastructure and improvement in social sector to align expenditure with social responsibility.

A considerable drain on government resources has been the increasing burden of contingent liabilities in order to cover the losses incurred by public sector enterprises (PSEs). Accordingly, the contingent responsibility of the government has, most of the times, transformed to a reality as these bodies lacked the capacity to service their obligations.