The Finance Ministry just managed to restrict the growth of the consolidated fiscal deficit but it could not contain it to the permissible limits. The deficit declined by three percent YoY in 1QFY16 to Rs328 billion which is off by 11 percent from the IMF’s target of Rs294 billion – almost equal to the provincial deficit (Rs29 billion). The target was too unrealistic and the provinces did not post surpluses; so it was missed.
The shortfall was primarily in tax revenues which grew by eight percent (YoY), as opposed to the highly optimistic targeted growth of 20 percent. With a nominal GDP growth rate of between seven and eight percent; how on earth can 20 percent tax revenue growth be achieved? Yet FBR shall be accountable for not increasing tax collection as a percentage of GDP despite an array of newly introduced taxes – it stood at 2.1 percent of GDP. Dar responded to it with a change in the FBR team at top levels. Let’s see what magic wand the new team will wield to enhance the dismal tax-to-GDP ratio.
Direct taxes performed well with a jump of 26 percent to Rs240 billion in the 1QFY16; thanks to the one-time imposition of super tax and ever-increasing WHT. It is pertinent to note that WHT is technically a direct tax but in essence, it is an indirect form of taxation and mostly sellers/producers pass it on to buyers through steeper prices.
The poor performance of taxation is primarily attributable to sales tax which is down by two percent as compared to similar period of last year to stand at Rs253 billion. The depressed commodity prices and higher refunds committed by Dar are chief reasons for the slowdown in the collection of sales tax. Furnace oil prices fell sharply and must have dented the sales tax collections on this front. The overall imports are down and sales tax collected at import stage must have observed some decline. Higher taxation on HSD and Mogas bought some semblance, however, it was not enough to negate the broad-based fall.
There were rumors that IMF wanted to increase the rate of sales tax due to this poor performance. However, the Finance Minister wisely stood against the option and came up with other indirect measures such as higher custom, regulatory and excise duties. The sales tax, at 17 percent or more, is already too high as compared to many other regional economies and there is no rationale to increase it further.
The excise duty grew by 12 percent as smokers and drinkers paid higher prices for their bad habits. The customs duty collection observed a healthy increase of 23 percent to reach Rs80 billion as special duty on furnace oil and minimum import duties paid dividends.
Petroleum levy increased by 12 as due to low prices, consumption of petroleum products has increased and since PL is fixed in Rupees irrespective of price, the collection has jumped. The GIDC came to the rescue as the government has finally started collecting it from 4QFY15 onwards. It increased to Rs24 billion as compared to Rs7 billion in the similar period of the previous year. The overall surcharge jumped by 44 percent to reach Rs63 billion in 1QFY16.
The non-tax revenues increased by 14 percent to stand at Rs243 billion. This is despite the fact SBPs profits (biggest component of non-tax revenues) did not grow at all. SBPs profits were recorded at Rs68 billion in 1QFY16, similar to the tally from the same quarter of the previous year. However, full-year profits for SBP in FY15 were Rs399 billion due to the booking of HBLs privatization proceeds in it and this year there is nothing to glorify SBPs profits so there is likely to be a decline of Rs100 billion in FY16. The fall in SBPs profits is compensated by an abnormal growth in other non-tax revenues which more than doubled to reach Rs61 billion in 1QFY16. Knowing, Dar’s creative accounting there could be something fishy in this head.
Anyway, overall consolidated revenue grew by 12 percent to stand at Rs937 billion in the first quarter of the fiscal year. The fiscal team managed to limit the consolidated expenses growth at eight percent, so the deficit does not grow beyond bounds. A pleasant surprise is that the development expenditure did not become the scapegoat during attempts to contain the current expenditure.
Current expenditure is marginally up by three percent to reach Rs1,085 billion in 1QFY16. As a percentage of GDP, it declined from 3.83 percent (1QFY15) to 3.54 percent (1QFY16). The debt servicing cost increased by five percent in the first quarter, and the point of concern is six percent increase in domestic interest expense (YoY) to reach Rs397 billion despite 350 bps fall in interest rates. This demonstrates that how the massive conversions of PIBs have limited the benefit of lower interest rates for the government.
The surprising element is that a decline of twelve percent in defense expenditure in the first quarter at a time when the army is active on all fronts. Experts fear that this could be an accounting gimmick as the government may have stalled the releases to the armed forces by a week, to show better fiscal position to the Fund.
Pleasantly, the government opened its heart to spend on development. Consolidated PSDP increased by 57 percent to reach Rs146 billion in the first quarter. Federal PSDP was at Rs71 billion and the provincial share stood at Rs75 billion. However, don get too excited on the spending spree as last year, releases in the first quarter were too low. Let’s see how the Finance Minister negotiates with IMF on development spending in the coming quarter as full-year consolidate PSDP is budgeted at Rs1514 billion.
Thus, the fiscal deficit stood at Rs328 billion (1.1% of GDP) – lower than the previous year; even though the provinces showed a deficit of Rs29 billion as compared to a surplus of Rs58 billion in the similar period of last year. Incidentally, the provinces have shown a deficit for the first time since 4QFY12. Despite all these goodies, the problem lies in deficit financing as due to low-interest rates, the non-banking domestic financing sources are drying up. External financing came to the rescue as it increased by Rs81 billion (up by 119%). However, non-banking domestic financing declined by Rs77 billion (down by 37%). The government is finding it hard to sell PIBs/NSS given low domestic interest rates. These are being replaced by expensive Euro bonds.
Financing through domestic banks remained similar to the same period of last year at Rs139 billion. But the devil lies in the details; since the government had to retire SBPs debt as a condition of the IMF, the onus is falling more and more on commercial banks. This leads to crowding out of private credit.
In a nutshell, the fall in interest rates is not working for the fiscal house – it is reducing the collection of sales tax, making it harder to directly sell PIBs and these have to route through commercial banks via SBPs liquidity pumping through the discounting window. And then the government has to rush to the international market to issue Euro bonds at inopportune times. Dar must be in a fix and pondering whether to dictate another rate cut or not in the upcoming policy review.
Originally published: November 19, 2015 in the Business recorder (BR) research.
