Pakistan’s fiscal policy at a crossroads

Islamabad:

Fiscal policy in Pakistan is usually far from a fine balancing act and is more of a reckless feat. It has long been characterized by a contentious debate between austerity measures and stimulus measures – with the government oscillating between these two approaches, often recklessly.

Thanks to these policies, the past three years have been marked by high interest rates – a result of the State Bank of Pakistan’s (SBP) battle with inflation that has crushed the real estate market and pushed up unemployment numbers. But why Pakistan’s policy rate should be as high as 22% for so long remains a burning question. The root of this problem lies in the extravagant expenditure of the government machinery which includes salaries, pensions and other benefits amounting to about Rs 5 trillion. These expenditures have in the past and now been financed by expensive debt and currently interest payments alone eat up most of the federal budget.

To discourage government borrowing and push it towards austerity, SBP hiked interest rates post-Covid. The Covid-19 stimulus package for Pakistan was valued at Rs 1.2 trillion, with an additional supplementary grant of Rs 100 billion for residual/emergency assistance.

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

Unfortunately, such messages seem to have fallen on deaf ears as far as the government is concerned and the feedback loop is apparently broken. The increase in wage and pension costs in the last budget by up to 35% speaks for itself how serious the government is about austerity measures.

Besides, the funny thing is that even in this budget there are proposals to inflate the payroll expenditure by another 12%. This staggering rise in government spending was not financed by increased income taxes and revenues, leading to a permanent fiscal deficit that required further borrowing through the issuance of more bonds at higher interest rates to attract investors.

It has indeed become a vicious cycle where government spending is covered by expensive loans from commercial banks, causing persistent inflation and little access to capital for private players. For now, the only way forward for the federal government is to keep another cycle of external debt and investment going – be it the IMF, CPEC, SIFC or CPEC 2.0. Only then can our political establishment fulfill its obsession with GDP growth numbers and continue to fund its political schemes and pet projects.

However, amid all this pessimism, we can still opt for a two-tiered approach to fiscal policy that supports austerity at the center but stimulus at the periphery (provinces) – combining the best of both worlds.

Austerity at the center

In this proposed model, the federal government can prioritize deficit reduction through spending cuts in the next budget and sweeping tax reforms. Although a performance-based budgeting process is already in place, we must also ban supplementary budgets. and requests for retroactive settlement of such grants should be penalized.

Rather than seeking more capital, government agencies should explore monetary returns on underutilized government assets through public-private partnerships (PPPs) or strategic divestitures. This could generate revenue while maintaining essential services. An example could be allowing private companies to use underutilized meeting/boardrooms in ministries through an online booking system for hourly payments.

Another approach to reduce the fiscal burden at the center could be devolution of specific ministries to provinces, as agreed under the 18th Constitutional Amendment, but still pending even after 14 years. Likewise, the regressive tax system should be replaced by a progressive one that places more burden on high income earners and lowers the tax burden on low and middle income groups. This could include wealth taxes, luxury goods taxes or revision of income tax brackets.

Fiscal stimulus for the 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. The provinces, not the P-block in Islamabad, should design and finance the transport networks, energy networks, water 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 the provincial government and leverages the expertise of the private sector.

By identifying good projects, provincial infrastructure bonds can be issued to raise capital from domestic investors. However, this requires strong creditworthiness and a clear plan for project returns.

Provinces can also provide stimulus packages by implementing targeted social security programs to support vulnerable populations and stimulate domestic demand. This could 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 for marginalized populations.

However, any incentive from the provinces 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 diversified approach to reconcile fiscal deficit and growth objectives.

A coordinated federal-provincial strategy, where the federal government implements austerity measures to address macroeconomic imbalances while the provinces pursue targeted fiscal stimulus to stimulate growth and job creation, can help achieve an optimal balance between fiscal consolidation and economic expansion.

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

Published in The Express Tribune, May 27^u2024.

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