Pakistan heading for new financial crisis

* Analysts say miniscule tax revenues, mismanagement and overgenerous subsidies mean country faces major financial crisis

Miniscule tax revenues, mismanagement and overgenerous subsidies mean Pakistan is heading for a new financial crisis, say diplomats and analysts, with this week’s budget unlikely to offer any respite.

The budget deficit stood at 6.6 percent of GDP last year, according to the State Bank of Pakistan (SBP), which warned that government borrowing was crowding out the private sector from access to credit.

That reduces the prospects for economic growth in a country that is on the front line of the war against al Qaeda.

External forecasts for the current fiscal year see the budget deficit rising to about seven percent of GDP, while economists warn the government is running out of ways to fund it.

Some see little alternative to a major financial crisis or a return to the IMF, which bailed out Pakistan with $11.3 billion loan package in 2008 that stopped last November after Islamabad rejected strict reform demands.

“I think it’s possible they could have a real financial crisis by the middle of this year or the fall. I don’t think it’s a question of if, but when they go back to the IMF,” one Western diplomat said.

Pakistan’s tax revenues are among the lowest in the world at just 9.8 percent of GDP in fiscal 2010-2011, says the Asian Development Bank, and less than two percent of the population pays tax on their income.

“There’s not really any money coming in, and that being the case, the government is financing itself by borrowing from the local banks and the local banks aren’t seeing deposits coming in to keep up,” said Liz Martins, an economist with HSBC.

The pressure on finance houses “means they have very limited money to lend to the private sector”, she said. “There’s no money coming from the IMF, no money coming from the bond markets, and international investors are very cautious.”

Islamabad borrowed Rs 365 billion from the banking system – both private banks and the SBP – in the first half of the current financial year, the central bank said in its second quarter economic report.

With inflation already running at around 11 percent, the alternative of printing money to pay debts opens the way to the nightmare of hyperinflation.

The IMF says Pakistan needs to raise tax revenues substantially to reduce the deficit sustainably, but with an election due within months analysts do not expect Finance Minister Abdul Hafeez Shaikh to follow its advice in budget on Friday.

“I don’t think the government is able to bear the terms that come with going back to the IMF,” said Sartaj Aziz, former finance minister.

Officials from the Finance Ministry were repeatedly contacted, but declined to comment on how they planned to finance the deficit. afp

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