The present government will be presenting its third budget on June 5, 2010. A budget is not only an account of revenue and expenditure of the government, but it also reflects the government’s policy stance to address the challenges facing the economy. Pakistan’s economy is currently facing one of the worst and complicated crises in its economic history. Adverse internal and external developments of an extraordinary nature notwithstanding the inept handling of the economy for over two years have aggravated the miseries of the people. An extremely careful handling of the economy is required at this moment in time.

The declining investment, slow economic growth, shrinking capacity of the economy to create jobs, rising unemployment and poverty, persisting double-digit inflation, mounting debt burden, depreciating exchange rate, crippling effects of power mismanagement on the economy, and waning confidence of the private sector on the country’s economic management are some of the critical challenges that the country is currently facing.

How to address the above-listed challenges through the Budget 2010-11 is the subject matter of this article. What should be the strategy for Budget 2010-11? The government has two options: either to go for a growth-oriented budget by creating more macroeconomic imbalances or strive for macroeconomic stability with higher growth on a sustained basis later. Both options have costs and benefits and their policy direction would be different as well.

The government may like to make the budget a growth–oriented one with a view to creating more jobs and providing “relief to the poor”. Such a strategy would encourage the government to go for a higher budget deficit in the range of 5.5-6.0 per cent of the GDP. In other words, fiscal profligacy would be required to achieve higher economic growth. The government may also force the SBP to ease monetary policy by reducing the discount rate. This may encourage the private sector to come forward and raise investment to kick-start the economy. Thus, expansionary fiscal policy and easy monetary policy would revive economic activity and create employment opportunity.

Is this a viable strategy? Do we have room for such an expansionary fiscal policy? In my humble opinion this would be a one-off strategy with disastrous consequences for the economy going forward. Pakistan is already drowned in debt and such a strategy of fiscal activism would create even more difficulties for the economy. It is an established fact that the root cause of the unsustainable debt burden and the attendant rise in macroeconomic imbalances is the persistence of large budget and current account deficits. One cannot expect the private sector to come forward and increase investment in an unstable macroeconomic environment.

Some government economists may argue that the government should undertake massive public sector spending (the Keynesian approach) to kick-start the economy. This is not a viable option as there is very little fiscal space available to undertake such a programme without further aggravating the debt situation and creating even greater macroeconomic instability. Growth may pick up temporarily by pumping more money in 2010-11 but little or no growth would be in store going forward. Furthermore, higher budget deficit would worsen the current account deficit and Pakistan may face difficulties in financing the external gaps.

Pakistan must not take this route. The strategy of pumping more money to kick-start the economy at this stage will have disastrous consequences. The government must avoid fiscal activism and populist measures to provide “relief to the poor”. Maintaining financial discipline is in the larger interest of the government itself. The government must not be seen as a fiscally irresponsible government. It must know that growth cannot be revived on a sustained basis without achieving macroeconomic stability. Empirical evidence around the world suggests that macroeconomic instability has generally been associated with lower growth, higher unemployment and more poverty.

This leads to the second option, which is, making efforts to achieving macroeconomic stability today with higher growth on a sustained basis tomorrow. The government should use the forthcoming budget as a vehicle to achieve macroeconomic stability. What should be the strategy for it? The government must target fiscal deficit at 4 per cent of the GDP in the next budget. The way to achieve this target is to set the resource envelope first. Every effort should be made to mobilise more resources (tax and non-tax revenues) and then add 4 per cent of budget deficit (this represents government borrowing) to arrive at the total envelope which will be spent during 2010-11.

There are three major expenditure items of the federal government, namely, interest payments, defence and security-related expenditures and running civil administration. These expenditures are committed and have no room for any meaningful reduction. After meeting these expenditures, the government will have to earmark some resources for subsidies and grants. Whatever is left thereafter can be utilised to finance development spending. In other words, development spending may be treated as residual for at least two years.

The reduction in budget deficit would reduce the borrowing needs of the government, slow the pace of accumulation of public debt, release pressure on the interest rate and help the SBP reduce discount rate which would then encourage the private sector to undertake new investment. It will also improve the external balance of payments by reducing aggregate demand and help contain monetary expansion to have salutary impact on inflation. Freezing the support price of wheat for two more years would go a long way in bringing the inflation down to single-digit.

Given the current economic challenges, the second option is the only option available to the government for budget strategy. What is required the most at this critical juncture is financial discipline and not fiscal activism. Let the next budget be a budget for stability. The economic team led by Dr Hafeez Shaikh must convince the political leadership of keeping the budget deficit low.

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

Source: The News, 11 May 2010

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