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Pakistan entered a new fiscal year a week ago. Will 2010-11 be a year of stability or bankruptcy? That will depend entirely on the political leadership, in particular the federal and provincial governments. If they behave collectively in a fiscally responsible manner, Pakistan may achieve relative stability by the end of the fiscal year. If they continue to behave in a fiscally irresponsible manner, bankruptcy by the end of December is a sure outcome. The consequences of this would be horrendous for the country.

The federal government has set the overall fiscal deficit (OFD) target for 2010-11 at 4.0 per cent of GDP, or Rs685 billion. In setting this target, the federal government assumed that the provincial governments would generate a surplus cash balance to the tune of Rs167 billion, or 1.0 per cent of GDP, because they are expected to receive over Rs500 billion additional resources under the new NFC Award.

To the dismay of the ministry of finance, Sindh, Punjab and Balochistan presented a deficit budget, while Khyber-Pakhtunkhwa presented a balanced one. A deficit budget means that the provinces have decided to spend more than their revenues. This simply suggests that the provinces will be spending over Rs500 billion more compared to last year. This is the height of financial indiscipline.

With the presentation of deficit budgets by three provinces and a balanced budget by one, the fiscal year has begun with a deficit target of 5.4 per cent, of GDP, or Rs923 billion. The anticipated slippages on revenue and expenditure sides are projected to further widen the deficit in the range of 6.5–7.0 per cent of GDP, or Rs1,100-1,500 billion.

Fiscal 2009-10 ended with a deficit of close to six per cent of GDP against the target of 4.9 and 5.3 per cent in 2008-09. What is surprising is that Pakistan’s budget deficit is rising in the midst of the IMF programme. What a benign IMF programme this is.

In 2010-11 the fiscal deficit is projected to be Rs1,100-1,500 billion. How would Pakistan finance such a large fiscal deficit when there are risks associated with inflows from external sources (the Tokyo Pledges, Eurobond and the Kerry-Lugar Act)? Pakistan is expected to finance the budget deficit from external sources to the tune of Rs186 billion, of which Rs177 billion is at stake. Even if we assume that Pakistan will receive Rs186 billion from external sources, it will still need close to Rs1,000 billion from domestic sources.

Can the finance team mobilise Rs1,000 billion from domestic sources? Will commercial banks participate in T-bills and PIB auctions at the current interest rate? The answer is obviously no. The State Bank will have to provide a sweetener to commercial banks to entice them into participating in these auctions. In other words, the State Bank will be forced to raise the discount rate. The overall lending rates will rise, thus increasing the cost of borrowing. Such a large borrowing by the government would leave very little credit available to the private sector (the crowding-out phenomenon). Investment would fall, growth would decelerate and unemployment and poverty would rise further. Inflationary pressure would continue to intensify. A high discount rate may give rise to non-performing loans by commercial banks. The exchange rate would depreciate, thus adding more to public debt and further contributing to inflationary pressure.

Do we want to see Pakistan in such a pathetic state of affairs? Two factors have contributed, or are contributing, to such a serious development: the irresponsible financial management of the provincial government, and the politicisation of VAT. The financial indiscipline of the provincial governments has already created serious difficulties. If VAT is not levied from Oct 1, Pakistan will face serious consequences by December. There will be no money from the IMF, the World Bank, the Asian Development Bank and the Kerry-Lugar Act if VAT is not implemented. This is no time for politics. The political leadership must realise the gravity of the situation and not oppose the VAT.

What needs to be done? The prime minister must call an immediate meeting of the political leadership, including the chief ministers and governors of the provinces and the heads of the political parties represented in parliament. The finance team must brief the political leadership about the state of finances and the consequences of not adhering to the principle of sound fiscal management, a briefing similar to the one given by the COAS to the political leadership on security issues.

The chief ministers must commit to delivering a surplus budget of at least 1.5 per cent of GDP by cutting their massive spending. The prime minister must commit to downsizing the cabinet to 20-25 ministers, take the allocation to the Benazir Income Support Programme back to the actual spending of 2009-10, rationalise allocation for the IDPs, reduce subsidies to bare necessities and rationalise other current expenditures. Countries like the UK, Greece, Spain, Portugal, Italy and Iceland are, on the one hand, taking massive austerity programmes, and taking revenue measures, on the other.

We need to do the same. If we do not undertake austerity measures, the IMF will force Pakistan to take them in the next programme. Pakistan is passing through the most difficult time of its history. The political leadership must realise the gravity of the situation and act fast.

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

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