October 31, 2019 (MLN): The fiscal performance of Pakistan’s economy was devastating during FY19. The aggregate fiscal deficit recorded at a historic high of 8.9% of GDP; it was higher than the targeted set of 4.9% in the Budget 2018-19.

The main cause of this deterioration was the decline in revenue collection and a sharp rise in current expenditure during the said period.

More notably, the other factors which are beyond the control of fiscal authorities also attributed to worsening the fiscal performance which included: a sharp rise in interest rates which increased the debt servicing burden, political regime shifting, legal constraints on the revenue side and overall slowdown in economic activities.

Total revenues declined by 6.3% during FY19, largely stemming from a sharp reduction in nontax revenues. Tax revenues recorded a marginal growth of 0.1% in FY19 which was apparently attributed to a decline in PSDP expenditures and court orders to considerably reduce the sales tax rate on major petroleum products and suspend the deduction of withholding tax on mobile phone top-ups. 

Indirect taxes slowed down considerably with the growth rate of 3.4% when compared to the 17.1% targeted budget of FY19. Sales tax collection declined by 1.8% during FY19 as compared to a growth of 11.8% during FY18. The entire decline in the sales tax revenue, the single-largest revenue source for the government, was attributed to lower collection from petroleum. Excluding this one item, the sales tax revenue rose to 7.2%.

The imposition of additional regulatory duties and PKR depreciation (which led to an increase in value terms of imports despite lower quantum) helped customs duties grow by 12.7% as compared to 22.4% last year. All the major drivers of custom duty collection recorded growth, with the exception of vehicles. It is important to note that while the overall import values have increased, their growth has slowed down considerably compared to last year.

FED collection also increased by 11.6% during FY19 compared to a 7.9% growth witnessed during FY18.

On the other hand, direct taxes declined by 5.9% due to a decline in withholding taxes, sharing 65% in direct taxes during FY19 against a growth of 14.3% reported in FY18. Compared to the revised estimates, FBR revenues fell short by Rs 321.5 billion, which turned out to be a major factor in the overall weak fiscal outcome and growing debt sustainability issues during the year.

The revenue-led fiscal stress was reinforced by overall weak expenditure controls at both the federal and provincial levels.

The provincial tax revenues grew by a meagre 0.1% during FY19 as compared to 24.7% increase recorded last year. This stagnation was explained by a sharp 9.4% decline in collections from General Sales Tax on Services (GSTS).

Moreover, a hefty loss incurred by SBP in the fourth quarter wiped out more than a third of overall non-tax revenues collected during the first three quarters. Taken together, the fiscal cost of the decline in revenues under these heads (petroleum and SBP profits), stood at 1.1% of GDP.

On the expenditure front, the total spending grew by 11.3% during FY19 as current expenditures recorded a sharp acceleration, up by 39.4%, mainly due to higher interest payments.

Here, it is important to highlight that the provinces registered a decline of 3.5% in their expenditures during FY19 as compared to an increase of 14.3% recorded last year.

The overall mark-up payments during FY19 were 29.1% higher compared to expense targeted in the Budget 2018-19. The resultant fiscal stress can be seen from the fact that interest payments alone ate up nearly 55% of the total FBR’s taxes during FY19.

The second big item within the current expenditures was defence, which showed an increase of 11.3% compared to last year. The entire increase was recorded in the first three quarters, as there was a YoY decline in defence spending during the fourth quarter. Moreover, the overall defence spending was largely aligned with the targeted spending for the year.

A sharp decline in development spending by 25.6% owing to a sharp reduction in PSDP spending both at the federal and provincial fronts,  was not enough to control the pace of total spending.

Encouragingly, the progress on ongoing CPEC projects was not compromised, as reflected by the higher spending on these projects compared to last year. Nonetheless, the overall control on development spending was insufficient to plug the large fiscal gap stemming from the subpar revenue performance and higher debt servicing. Therefore, the government had to finance the gap by accumulating a record-high level of debt during the year.

The outlook for the fiscal sector, by contrast, is not straightforward. The FY20 budget looks to fix the deficiencies of the tax system and represents an earnest effort to increase documentation. It envisages a sizeable reduction in the deficit, by enhancing revenues and squeezing expenditures.

However, achieving the ambitious tax collection target in the middle of a broader economic slowdown may present a challenge. Moreover, even if things pan out more or less according to plan, the fiscal deficit may be in the neighborhood of 7%, nevertheless, implying that there would still be some way to go before fiscal consolidation is achieved. The government is expected to make an intensive effort to meet the IMF’s quarterly targets, implying a measure of fiscal discipline.

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