Fiscal policy statement- By Dr Ashfaque H Khan

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The Debt Office of the ministry of finance has released Fiscal Policy Statement 2009-10 in end-January 2010 to fulfill the requirement as laid out under section 6 of the Fiscal Responsibility and Debt Limitation Act 2005. In my last article (February 9) on Debt Policy Statement, I had appreciated the quality of the document. However, the quality of the Fiscal Policy Statement is far from satisfactory. This document not only misrepresents facts, at times it contradicts facts as presented in the tables. In other words, the text of the document is not in line with the facts reported in various tables. Furthermore, it indulges in “defending the indefensible” (borrowed the term of my friend Meekal Aziz Ahmed)

In this article, I would point out those misrepresentations and present the facts to keep the record straight. The document states that “lax fiscal stance of the last eight years (2000-07) has a definite bearing not only on the fiscal adjustment process but macroeconomic stability as well”. In economics literature, the lax fiscal stance represents rising fiscal deficit. The table presented in the document (Table 2) simply contradicts the statement referred above. Fiscal deficit as percentage of GDP averaged 7.0 per cent in the 1990s which was reduced to 4.0 per cent during the period 2000-07. Further analysis of the document under review would reveal that the deficit averaged 3.7 per cent of GDP. Does reduction in fiscal deficit represent lax fiscal stance?

A more in-depth analysis of fiscal deficit would reveal even more interesting facts. Fiscal deficit was 6.1 per cent of GDP in 1998-99, reduced gradually to 2.4 per cent by 2003-04 but jumped to 4.2 per cent and 4.3 per cent in 2005-06 and 2006-07, respectively. Why fiscal deficit surged to over 4 per cent in these two years? The table itself states that 0.8 per cent and 0.5 per cent of GDP worth of additional expenditures were incurred on account of earthquake. Adjusting for earthquake-related expenditures, the fiscal deficit remained at 3.6 per cent of GDP, totally in line with the then government’s stance to keep deficit below 4 per cent of GDP. Keeping fiscal deficit below 4 per cent of GDP was consistent with the debt reduction path as enshrined in the Fiscal Responsibility and Debt Limitation Act 2005. The present government has itself acknowledged in Debt Policy Statement 2010 that Pakistan achieved the debt reduction target of 60 per cent of GDP much ahead of the specified time. In fact, Pakistan succeeded in reducing public debt from over 80 per cent of GDP to 55.5 per cent – a reduction of 24.5 percentage points in just six years. Can this reduction take place in a lax fiscal stance environment? Any student of economics would argue in negative.

Let me delve a bit more on the issue of “lax fiscal stance”. The document states that “the period 2000-07 was the best period for expenditure rationalisation…”. A cursory look at Table 2 of the document would reveal that current expenditure continued to decline as percentage of GDP from 16.5 per cent to 14.4 per cent during 2000-06 but increased to 15.8 per cent in 2006-07. Why current expenditure continued to exhibit a declining trend but increased in 2006-07? The answer lies with the trends in interest payment. Interest payment being the single largest component of the total expenditure stood at 37 per cent in 1999-2000 but continued to exhibit a declining trend until 2005-06 when it declined to as low as 17 per cent – a reduction of 20 percentage points in its share in total expenditure in just six years.

Interest payment surged in 2006-07. What happened in this particular year and beyond? The answer to this question takes us back to the year 1996-97 when the then caretaker government increased the rates of return on various instruments of National Savings Scheme, particularly the Defense Savings Certificates. As a result, massive investment took place in this Certificate. After ten years when this certificate matured, interest payment ballooned in 2006-07 and this trend is still continuing. It is for this reason that interest payment jumped from 3.1 per cent of GDP a year ago to 4.2 per cent in 2006-07, causing current expenditure to rise from 14.4 per cent to 15.8 per cent. The then government paid the price of fiscal profligacy of the late 1990s. Adjusting the slippages in interest payment and earthquake-related expenditures, the budget deficit in 2006-07 stood at 2.7 per cent of GDP. Is this a lax fiscal stance?

There is yet another way to look at “lax fiscal stance”. Non-interest, non defense expenditure, that is subtracting interest payment and defense from total expenditure, is yet another measure of fiscal prudence or the lack of it. This expenditure stood at 7.7 per cent of GDP in 1999-2000 but gradually increased to 12.1 per cent by 2006-07 – an increase of 4.4 percentage points during the period (2000-07) of “lax fiscal stance”.

The fact of the matter is that Pakistan pursued a relatively sound fiscal policy consistent with debt reduction strategy. It succeeded in keeping fiscal deficit at or around 4.0 per cent of GDP resulting in sharp reduction in the country’s burden. Reduction in fiscal deficit released resources from interest payment which were then diverted towards development spending. Such a fiscal stance helped Pakistan achieve strong economic growth, reduction in unemployment and poverty. Higher economic growth for over five years in a row helped reduce unemployment from 8.3 percent to 5.2 per cent and poverty from 34.5 per cent to 17.2 per cent. This is the way going forward.

A sound fiscal position is key for achieving macroeconomic stability, which is increasingly been recognised as critical for sustained economic growth and poverty reduction. The sooner Pakistan improves its fiscal position by making sharp fiscal adjustment, the better it is for growth and poverty reduction.

The writer is director general and dean at NUST Business School, Islamabad. Email: ahkhan@nbs.edu.pk

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