The government adopts an irrational pricing policy

LAHORE:

Pakistan faces a low-growth trap, while the new budget effectively increases spending through more borrowing and a higher tax burden.

Rising spending, based on heavy borrowing, only increases payments for borrowing, which now account for 57% of total spending. This policy is clearly useless and unsustainable. Therefore, this perverse Gordian bond should be broken.

This is the focus of a report titled ‘State of Pakistan’s Economy, Growth, Inflation, Welfare and Budget 2024-25’, released by the Lahore School of Economics.

According to the report, the budget for the financial year 2024-25 is particularly ambitious, where the expenditure has increased from Rs 14.5 trillion (FY24) to Rs 18.9 trillion. It is because the budget base – tax revenue – is projected to expand from Rs9.4 trillion last fiscal year to Rs12.9 trillion this year, an ambitious target that is higher by Rs3.6 trillion.

The imperative to push taxation above 10% of gross domestic product (GDP) is accepted without any economic debate and lacks context. Already, the economy is caught in a low-growth trap, with declining investment and increasing capital outflows.

“With large-scale manufacturing shrinking over the past two years and the economy running on agriculture alone, increasing taxation will not reverse this low-growth trap,” the report said.

This is the absurd pricing policy in a market economy. The budget seeks to match the scarcity of revenue with the needs of expenditure. Last year’s revenues made up only 48.2% of the total budget, necessitating reliance on borrowing for more than half, 51.8% of the budget.

This is largely enforced by the transfer of all federal revenues to provinces, leaving the federation with only 1% of total budget revenues and making it entirely dependent on borrowing to meet spending obligations.

The ambitious revenue target for FY25, which is 55% of the budget, aims to reduce reliance on borrowing to 45%, the report said. For FY25, spending rose to Rs 18.9 trillion compared to Rs 14.5 trillion in FY24, an increase of nearly 30%. Given the reliance on borrowing, this large increase in spending is useless.

The biggest ticket item in current spending continues to be loan repayments, rising from 54.8% of total spending last year to 56.8% this year.

According to the report, there are two imperatives for the economy. The first is the reduction of borrowing and its cost. The increase in spending, more than half of which comes from borrowing, is not sustainable or rational. Therefore, spending must be cut and the fiscal deficit reduced.

The second is to create growth, but if significantly increased taxation is a disincentive to growth, then again, spending must be reduced to better match existing taxation. If there are some expenses that need to be hedged, the needs of the state come to mind, so does welfare.

Prosperity must come to the fore. As a result of rising inflation, which peaked at 33% in the financial year 2022-23, incomes have been eroded, especially for the lowest decile in the income distribution.

The number of people in poverty rose from 5% of the population in 2019-20 to 9% in 2021-22 and then doubled to 18% in 2022-23.

The LSE has estimated that eradicating extreme poverty will require non-reciprocal transfers to the poor of 10% of income. If this is a big ask for a growing economy, a more immediately achievable amount can be appreciated.

“We calculated that the poor spend a quarter of their calorie basket on wheat and bread. This is the first step in poverty eradication to spend 2.5% of revenue to provide free wheat to the poor means-tested population,” the report added.