The government of Pakistan’s second mini-budget supports exports, but increases fiscal consolidation challenges, says Moody’s Investors Services.
Moody’s in its latest report states that on 23 January, Pakistan’s (B3 negative) Finance Minister, Asad Umar, announced the government’s second mini-budget, which largely focuses on revenue-based measures to improve supply-side conditions for businesses and incentivize domestic reinvestment. If effective, the measures will support Pakistan’s manufacturing sector, fostering exports and import substitution, and help narrow the current-account deficit.
In the absence of new spending cuts or revenue-raising measures, however, these measures will keep Pakistan’s budget deficits wider for longer, potentially eroding the credibility of government efforts to achieve fiscal consolidation.
Compared with the government’s first mini-budget in September 2018, which emphasized spending cuts, the second mini-budget aims to improve business conditions, including for manufacturers and exporters, by removing or reducing existing taxes that erode profit margins or disincentivize reinvestment.
Specific measures include reductions in import customs duties on essential raw materials and machinery, the abolition of tax on retained earnings, and incentives for the agriculture sector, which accounts for around 20% of the country’s exports.
While the mini-budget will support the export sector, there is a greater risk of fiscal slippage and slower fiscal consolidation in the absence of further revenue-raising measures. Pakistan’s revenue base was a narrow 15.4% of GDP in fiscal 2018, which ended in June 2018. The government presented limited revenue-raising measures, primarily taxes on large vehicles and high-end mobile phones. As a result, the mini-budget places greater weight on improvements in tax administration and spending restraint for the government to meet its deficit target of 5.1% of GDP.
“We expect the deficit to widen to 6% of GDP in fiscal 2019 because revenue growth is likely to be below government projections, given slower economic growth and the new revenue-based incentives, before gradually narrowing to 5% of GDP by fiscal 2021 as the economy picks up. While we believe the government remains committed to fiscal consolidation, a wider for longer deficit could raise questions over the credibility of its fiscal policy”, says Moody’s.
The mini-budget comes against a backdrop of low export growth in the first six months of fiscal 2019, despite the Pakistani rupee’s 25% decline against the US dollar since December 2017. The government is seeking to narrow the current-account deficit by reducing some of the tax distortions exporters face.
Weak exports aside, Pakistan’s current-account dynamics have been largely positive in recent months. Remittances rose by 10% year on year in US dollar terms in the first half of fiscal 2019, while goods imports slowed sharply to around 3% year on year as non-fuel goods imports contracted. “However, although we expect the current-account deficit to narrow to 4.7% of GDP in fiscal 2019 and to 4.2% in fiscal 2020 from 6.1% in fiscal 2018, it will remain sizable and wider than in 2013-16, driving Pakistan’s external financing needs,” the report added.
The government has secured $12 billion in financing from Saudi Arabia (A1 stable) and the United Arab Emirates (Aa2 stable) – in each case amounting to $6 billion and divided equally between deposits and deferred oil payments – which is likely to largely cover the country’s net financing needs for fiscal 2019. However, a net financing gap beyond fiscal 2019 remains because of the still sizable current-account deficit.
Pakistan remains in negotiations with the International Monetary Fund over a new program that would provide a stable additional source of external financing, as well as technical support and assistance on macroeconomic rebalancing and structural reform policies. The country is also in discussions with other countries and multilateral lenders such as China (A1 stable), Qatar (Aa3 stable), the Asian Development Bank (Aaa stable), the IBRD (World Bank, Aaa stable) and the Islamic Development Bank (Aaa stable) over external funding support to shore up its external position.