Research and analysis

Pakistan’s budget: another step forward - June 2014

Published 6 June 2014

0.1 Detail

Finance Minister Ishaq Dar’s launch in early June of the 2014/15 Budget marks the first anniversary of Nawaz Sharif’s administration and the start of the second year of the three year IMF Extended Fund Facility which PML-N agreed to avert looming fiscal and balance of payments crises. Although the IMF got just a single mention in Dar’s speech, the budget seems consistent with the EFF reform programme.

The focus of the EFF is on fiscal consolidation, cutting the deficit from 8.2% of GDP in 2012/13 to 4% in 2015/16, through a combination of tax measures and expenditure cuts, particularly electricity subsidies, and privatisation. A reasonable start has been made, with the first three quarterly reviews completed. The 2013/14 deficit is expected to be 5.8% of GDP, an improvement on the EFF target of 6.3%. With tax revenue somewhat below target, this is largely due to cuts/delays in capital expenditure. GDP growth is expected to be 4.1%, somewhat above the EFF forecast. Crucially, a balance of payments crisis has been averted; reserves are being rebuilt and the Rupee has stabilised. Reduced government borrowing has allowed increased credit to the private sector. The Karachi Stock Exchange is booming.

The fiscal strategy for 2014/15 is unchanged and in line with the medium term economic framework presented last year. The deficit is to be reduced further to 4.9% of GDP through both expenditure and revenue measures, while containing inflation at 8%.

On the expenditure side, loan interest and Defence increase by 3.6% and 2% in real terms, representing 30.8% and 16.3% of total federal expenditure respectively. Allocations for the Benazir Income Support cash transfer programme have also been increased by the amounts agreed with the IMF to increase stipends in real terms and extend coverage. The speech trumpets a 24% increase in capital expenditure and a long list of infrastructure projects.

Despite the increases, total expenditure decreases (by 6% in real terms) from 20.9% of GDP in 2013/14 (revised forecast) to 19.4% - helped by a further cut in electricity subsidies of US$ 900 million (0.7% of GDP).

On tax, despite a 16.4% increase in 2013/14, federal tax is still only 9.0% of GDP; direct taxes, sales tax, FED and customs duty all fell short of target. New tax measures agreed under the EFF are expected to increase federal tax by 0.7% of GDP in 2014/15, bringing the tax/GDP ratio to 9.7% (11.5% including provincial tax).

Unlike 2013/14, when increasing the rate of sales tax was the largest source of extra revenue, GoP has not resorted to increasing tax rates. The Budget commits to raising tax equitably, by increasing the share of direct tax, broadening the tax net and improving compliance. Measures to capture missing income tax payers (notices to file returns) commenced this year under the EFF. The main new commitment is to phase out Statutory Regulatory Orders, exemptions from indirect taxes which cost over 1.5% of GDP in lost revenue and ‘distort the level playing field and breed corruption’, over the next three years. While not detailed in the Speech, the first set of SROs to be eliminated – worth at least 0.35% of GDP – is an IMF benchmark and was agreed during the latest EFF review.

Other tax measures announced include: advance tax on first and business class airline tickets, real estate, electricity bills, interest and dividends, cash withdrawals, car registration - all with higher rates for ‘non-compliant persons’; an ‘alternate corporate tax’ at 17% of accounting income if the amount exceeds regular corporate tax on taxable income; making a tax ID number a requirement for gas and electricity connections; closing various tax loopholes; and removing tax exemptions for foreign institutional investors.

The sales tax regime for small retailers is simplified, as is the trade regime. The number of customs tariff slabs is reduced from 7 to 6 and the top rate of customs duty from 30% to 25%. Inevitably there are also several ‘relief measures’ which reduce certain taxes as incentives to various activities, though they do not appear significant.

Dar also announced a number of export promotion measures intended to arrest the declining export / GDP ratio, including setting up an EXIM bank, reduced financing costs and promoting inland ports. There is no recognition of the damage caused to exports by Pakistan maintaining an overvalued exchange rate.

Comment

On first impressions the 2014/15 budget appears broadly consistent with Pakistan’s commitments under the EFF. Dar did not quantify the expected yield of individual tax measures, and it is too early to assess their likely impact. The calculations will be verified by the IMF. In any case, progress towards PML-N’s 15% tax / GDP target depends less on specific measures than on the Government’s determination to enforce tax laws - by pursuing non-taxpayers through the courts, impounding assets, etc. (many of the 2013/14 tax measures were quietly reversed within months).

The budget will now be debated in parliament. The opposition have attacked it for favouring business at the expense of the poor. The PML-N have enough of a majority to secure its passage, although there may be some changes.

0.2 Disclaimer

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