The outlook for Pakistan’s budget for the next financial year is challenging. At present, macroeconomic policies are overly expansionary and fundamental reforms to resolve the economy’s structural problems are not being tackled well. As a result, the economy is increasingly vulnerable with weak growth. The outlook is challenging.

The Finance Minister, Dr Hafeez Sheikh, must be clear that Pakistan’s budget needs to reform the energy sector to reduce power shortages and the large untargeted electricity subsidies, and more generally reduce the government’s footprint in the economy; and implement financial policies to reduce inflation, protect the external position, and safeguard the stability of the financial sector.

Electricity subsidies and interest payments consume almost half of the government’s revenues. A longstanding problem has been exacerbated in the recent years by a lack of investment, price distortions and poor management of the sector. While many reform plans have been prepared, implementation has not been sustained. As a result, there is large-scale loadshedding, causing loss of production in the industrial and agricultural sectors.

On current policies, Pakistan’s near- and medium-term prospects are not good. Growth would remain too low to absorb the large number of new entrants into the labour force, inflation would remain high and the external position would weaken significantly. Dr Sheikh has been relying too much on budgetary management, and on containment of investment spending and by credit from banks that further crowds out the availability of credit for the private sector.

The measures could include reforms to slow the challenges, overdoing fiscal adjustment in the short term to counter cyclical revenue losses demands for government spending. Most notably, subsidies (mostly electricity subsidies) and state-owned enterprises (PSEs), especially in the power, transportation and agricultural sectors, operate without hard budget constraints and incur large losses. Subsidies to cover these losses, which amounted to nearly 2 percent of GDP in 2010/11, divert resources away from more productive spending. The key to Pakistan’s external competitiveness is improving the security conditions, the reliability of energy supply and its business environment and governance.

Out of 142 countries included in the World Economic Forum’s Global Competitiveness Report 2011–12, Pakistan ranked 118th with weaknesses identified in:

i    Macroeconomic environment;

i    Labour market efficiency;

i    Higher education and training; and

i    Infrastructure.

In the World Bank’s Doing Business Report 2011, Pakistan ranked 83rd out of 183 countries; this indicates that the cost of doing business in the country could be reduced in the following areas:

i    Enforcing contracts;

i    Paying taxes; and

i    Registering property.

Based on the latest Country Policy and Institutional Assessment (CPIA) of the World Bank, Pakistan ranked 57th out of 77 low income countries with the following areas of improvement:

i    Macroeconomic management;

i    Fiscal policy; and

i    Transparency, accountability and corruption in the public sector.

Government tax revenue is about 10 percent of GDP, which is one of the lowest in the world. There is a general unwillingness to pay taxes, due to poor public service delivery and because of the perceived unfairness in the tax system. For example, a major sector - agriculture - is mostly outside the tax net, and the number of taxpayers filing income tax returns is very small.

Pakistan has confronted difficult challenges in the past few years, particularly after the takeover of President Zardari, which are external and domestic economic shocks, political uncertainty and security problems. President Zardari has not been able to visit the Pakistani troops although he is the Supreme Commander for fear of security. His party is in a state of disorganisation, while the understanding with the PML-N seems to be no longer working.

The countries with relatively strong fiscal and external positions, for example, should not adjust to the same extent as countries lacking those strengths or facing market pressures. Through mutually consistent actions, policymakers can help anchor expectations and re-establish confidence. In the near term, sufficient ‘fiscal adjustment’ is in motion in most advanced economies. Countries should let automatic stabilisers operate freely for as long as they can readily finance higher deficits. Among those countries, those with very low interest rates or other factors that create adequate fiscal space, including some in the euro area, should reconsider the pace of near-term fiscal. Therefore, budgetary management relies too much on the containment of investment. These have left Pakistan’s economy highly vulnerable, with few buffers to absorb the shocks.

To survive the forthcoming budget and overcome the cascading difficulties, urgent policy action is needed on three fronts to contain vulnerabilities and place Pakistan on a higher, inclusive growth trajectory. Zardari has been unable to order cuts in wasteful and low priority expenditure. In the next two to three years, further fiscal adjustment is needed and should be based on structural measures. With gradual deficit reduction and continued low borrowing costs (relative to inflation) over the medium term, Pakistan’s public debt would be sustainable. But the debt level is high, making it vulnerable to interest rate or exchange rate shocks. In addition, given the financing constraints, lower deficits would reduce crowding out and make more bank credit available for the private sector investment. In order to achieve this objective, decisive break with the past is needed.

n    The writer is a retired secretary of the Government of Pakistan.