Budget gap of Rs 600 billion

The debate on the budget is ongoing in the parliament to get necessary approvals and this is the right time to critically analyse the targets and assumptions made in the budgetary process.

One of the most critical element is the budget deficit target of 3.8 percent for FY17 which probably is too optimistic.

Let’s attempt to dissect various revenue and expenditure elements to gauge any gaps in the budget.

It’s counterintuitive that a budget with apparent generous packages for exports and agriculture sectors can slash the deficit to 11 years low, especially when elections are approaching. It’s too good to be true.

In case of FBR revenues, a 17 percent growth from a high base after achieving 19 percent growth in FY16 without adequate new taxation measures is a hard task.

The nominal GDP is estimated to grow by 13.2 percent in FY17, given the historic tax elasticity of 0.9, the tax growth will be 11.9 percent on existing base.

This means that net additional taxation should be 4.8 percent on existing base (Rs3104billion) which amounts to Rs148 billion.

To do so, some new taxes are introduced in the budget and some tax breaks are in the offing too.

There are tweaking in the finance bill which have adverse implication for various sectors in input adjustments.

Such as, while generously giving zero rating regime for textile exports, the insertion of non inviolable input sales tax of 5 percent on domestic sales in the value chain will increase the final tax incidence.

A few other sectors will face the similar issue; the overall sales tax incremental revenues due to non-invoicing of inputs will cascade to around Rs60-70 billion.

The new withholding taxes on builders and developers fixed in rupees is likely to add Rs 15-20 billion to the kitty while fixed rates on property tax is estimated to fetch Rs 15 billion.

The impact on super tax is already incorporated in the base. The higher FED on cement may add Rs 30 billion to FBR’s revenues.

By reverting to 0.6 percent tax on banking transactions for non-filers, the collection may increase by Rs10 billion.

After adding newly imposed taxes on packaged milk, stationery and other small items, the overall impact of new measures would be around Rs160 billion.

However, there are some relaxations proposed as well. The corporate income tax is slashed to 31 percent; with 80 percent of income tax collection from corporate; the FBR revenues may decline by roughly Rs30 billion.

There is an array of tax credit or deductibility announced on insurance, housing etc; it may lower the tax revenues by Rs15 billion.

The custom duty on large number of items which was at 5 percent is now reduced to 3 percent. Approximately 40 percent of imports fall in this category and the impact of 2 percentage deduction would be around Rs30 billion.

However, after netting the increase in duty on milk powder, smart phones and a few other items the net impact would slash to Rs15 billion.

Thus, the total tax breaks would likely touch Rs60 billion and the net incremental taxes may fetch Rs100 billion.

But the need is around Rs150 billion to meet 17 percent revenue targets; hence FBR targets may slip by Rs50 billion.

Eyebrows can be raised on some other revenue receipts such as Rs75 billion from 3G/4G licenses, Rs50 billion to be raised from privatization and Rs170 billion from defence services receipts as CSF is in doldrums; however, it’s better to assume that the government is serious on its commitments.

However, subsidies are ought to overrun. PML-N government has missed its subsidy targets by wide margins in all of its three years and the trend may continue in the fourth as well.

The government has optimistically slashed subsidy for WAPDA/PEPCO and KESC by Rs53 billion at the time when furnace oil prices are heading north.

FO is around 40 percent of the fuel mix and assuming higher oil prices, either the net subsidy impact would increase or government would revise up the electricity tariff. Let’s assume that latter is the case and electricity would be dearer in FY17.

But there is an announcement of Rs72 billion package on agriculture which will be equally shared by federal government and provinces and there is no mention of this in the budget document, hence the consolidated deficit may inflate by the same amount.

In case of current expenditure, modest 3.6 percent increase is unrealistic. The mark-up payment on debt is budgeted to increase by 3.4 percent which is too low given that it grew by 8 percent in 9MFY16.

The fiscal deficit of Rs1,278 billion in FY16 is incremental debt and will have additional servicing cost in FY17.

A subtle but scary trend is the projected shift in both domestic and foreign debt profiles. In FY16, within domestic debt the focus was on floating debt while in upcoming year the government is eyeing on accumulating high cost permanent debt.

However, with low interest rates the cost may be partially offset. But for external loans; there is no good news – Although the total external loans are estimated to decline a bit, the shift is from project and programme loans to commercial loans.

The former which is usually at concessionary rates is budgeted to decline by Rs277 billion and latter which is an expensive option would increase by Rs253 billion.

$1.75 billion are budgeted to be raised from Euro bond and Sukuk issuance mind you last Euro bond transaction was at an exorbitant 8.25 percent.

And government is eyeing to raise Rs211 billion from foreign commercial banks. Why this shift? Simply, the IMF programme is ending and no donor is comfortable in issuing fresh loans in the absence of the fund’s blessings.

The commercial loans, unlike donor funding, are usually without grace period and their servicing would start right away.

If the government is not able to raise $4 billion from foreign capital markets and commercial banks in FY17; it may revert to domestic sources.

With limited capacity of commercial banks amidst exit from IMF, the onus may fall on SBP borrowing.

Yes, the note printing machine may come back in action and that would cause an inflationary tax in subsequent years.

Anyway, the federal government naively announced high real increase in the salary and pensions for its employees.

The impact, according to budget speech, is Rs 57 billion. It’s a no brainer that provinces will follow suit and the number of employees in provinces are much higher than that in the center.

Assuming the incremental impact of provinces is double of federal counterpart, the overall impact on consolidated budget would be Rs 171 billion.

Oops, the slippages are getting out of bound. Summarising the impact of all – assuming Rs65 billion higher interest payments than what is budgeted, Rs 72 billion farmer package, Rs 171 billion higher expense on salaries and pension, and Rs 75 billion shortage in FBR revenues, the overall deficit may increase by Rs 383 billion.

And by adding refunds promised to textile exporters, budget deficit may be higher by Rs 600 billion or 1.8 percent of GDP. Good luck Dar and team! –Business Recorder