ARTICLE: There is the likelihood of a significant deterioration in the financial position of the Provincial Governments by the end of this fiscal year. The last quarter of 2019-20 is likely to witness the conversion of a large cash surplus of these Governments at the start of the quarter to a deficit by the end of the quarter. The primary reason for this will be the big fall in transfers from the federal government due to the precipitate decline in FBR revenues caused by Covid-19. The shortfall is likely to be as large as Rs 900 billion in relation to the original budget estimates. This is by far the largest shortfall ever.
The cash surplus of the four provincial governments combined on the 30th of April was Rs 394 billion, equivalent to almost 11 percent of the combined budgeted expenditure for 2019-20. Despite a peak normally in spending in the fourth quarter, under normal circumstances the year would have ended with a significant Provincial surplus of almost Rs 200 billion, equivalent to about 0.5 percent of the GDP. But by the 22nd of May, the surplus has fallen to Rs 148 billion, thereby showing a decline of as much as Rs 246 billion in only seven weeks. The level ofthe cash surplus on the corresponding date of last year was Rs 254 million. If this decline continues then the year could close with a combined cash deficit of almost Rs 150 billion. In fact, the IMF has projected that the four Provinces combined will have a higher cash deficit of over Rs 200 billion in 2019-20.
Historically, the four Provincial Governments have generated significant cash surpluses and made a contribution to the reduction in the consolidated deficit. Over the last decade, the biggest surplus of Rs 207 billion was achieved in 2015-16, equivalent to over 0.7 percent of the GDP. Cumulatively, since 2010-11, the cash surplus has been Rs 796 billion. The year 2015-16 also saw the fastest growth in transfers from the Federal Government of 21 percent. Since then, up to 2018-19, the average annual growth rate in transfers has fallen to only 8 percent.
There is also a need to examine if the transfers are being made to the provinces as per the 7th NFC Award. Has the quarterly growth rate in transfers in 2019-20 been, more or less, in line with the growth rate in the revenues from the divisible pool of taxes? During the first three quarters, the latter sources have shown a growth rate of 12.5 percent but transfers have risen by 8.5 percent. As such, the shortfall in transfers is close to Rs 70 billion. There is even the likelihood that in an effort to control its own fiscal deficit, the federal government may restrict further the transfers due in the last quarter. This will exacerbate the problem of large Provincial cash deficits as of the end of 2019-20. The past practice has been to make up the shortfall, if any, in transfers in the first two quarters of the next fiscal year.
What is the current financial position of each of the provincial governments as of the 22nd of May? The provincial government of Balochistan appears to be in the most favorable position with the cash surplus equivalent to over 14 percent of the likely expenditure in 2019-20. Sindh has a cash surplus of only 3 percent, while the cash surpluses of the other two Provinces, Punjab and Khyber Pakhtunkhwa, stand at 4 percent of the annual expenditure.
The next question is the extent to which the cash surplus of the provincial governments has been reduced by a faster build-up of development spending in the first three quarters of 2019-20? There has indeed been very high growth in PSDP spending of 38 percent by the four Governments combined. The budgeted growth rate is 20 percent for the year. As such, the extra spending up to the end of March is Rs 50 billion. This is not a very large divergence and it is likely to be eliminated by a much slower growth in development expenditure in the last quarter.
The bottom line relates to the projected financial position as of the end of 2019-20. Based on a higher expenditure in the last quarter due to larger outlays on health to tackle the growing incidence of COVID-19 cases and for providing relief to the affected, the combined expenditure could show a relatively high growth rate of over 20 percent in the fourth quarter. Transfers during this quarter from the Federal Government could fall by as much as 30 percent. Consequently, the combined deficit could rise to as much as Rs 550 billion in the fourth quarter. This implies that the Provincial Governments could end up with a combined deficit of over Rs 150 billion as of the 30th of June 2020. This will be by far the largest deficit ever.
There is a higher likelihood that the two larger Provincial Governments, Punjab and Sindh, could end the year with significant cash deficits. As opposed to this, Balochistan is likely to continue carrying a cash surplus while Khyber-Pakhtunkhwa could come close to balancing its budget, subject to the continuation of the receipt of hydro-electricity profits.
The respective provincial governments are probably immersed currently in the process of budget preparation for 2020-21. What is the likely financial outlook for next year? This will hinge fundamentally on the growth of transfers from the federal government. These transfers in turn will depend on how FBR revenues perform in 2020-21.
The IMF expects that FBR revenues will be able to show a growth rate of as high as 31 percent next year. This is highly improbable in the presence of a continued slowdown in the economy in at least the first half of 2020-21. Implementation of new taxation proposals will be limited by the low growth, and even decline, in the different tax bases.
An optimistic estimate of the growth rate in FBR revenues is 10 percent, with the level rising from under Rs3900 billion to just above Rs 4300 billion. If there is corresponding growth in transfers, then this will lead to a growth in total provincial revenues of 10 percent. Own revenues are unlikely to exceed Rs 520 billion in 2019-20. Here again, the increase is likely to be limited. Overall, the total revenues of the four Provincial Governments combined are likely to increase by about Rs 350 billion in 2020-21.
Therefore, the implied additional fiscal space is only Rs 350 billion. This will enable only a modest growth in expenditure, which will be inadequate to sustain the higher level of expenditure associated with COVID-19, both on the health sector and on some pro-poor interventions. It appears that financial constraints may also limit the annual granting of increases in salaries and pensions. Further, the ability to raise development spending sharply to promote economic revival and higher employment will also be constrained.
A projection has been made of the implications of a growth in current and development expenditure combined at the Provincial level of 17 percent. This implies an increase in total spending of over Rs 600 billion and a combined cash deficit of over Rs 250 billion in 2020-21. It could be even larger if FBR revenues continue to fall sharply for some more months.
The presence of the Provincial Governments in deficit implies that arrangements will have to be made for the requisite level of borrowing with prior approval of the National Economic Council, chaired by the Prime Minister. The Provinces of Punjab, Sindh and Khyber-Pakhtunkhwa are more likely to require access to borrowed funds.
The irony of this new development of large cash deficits in the budgets of the Provincial Governments comes at a time when there is more discussion on the NFC Award and the 10th NFC has been constituted recently. It is not true anymore that the distribution is skewed in favor of the Provincial Governments. They will no longer have cash surpluses under the present arrangements. There is need to recognize that the fundamental problem is the 'size of the cake' and not its distribution. Looking beyond 2020-21, an exceptional effort will have to be launched to raise substantially the tax-to-GDP ratio of Pakistan by both the Federal and Provincial Governments.
(The writer is Professor Emeritus at BNU and former Federal Minister)
The writer is Professor Emeritus at BNU and former Federal Minister
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