FISCAL POLICY

GROUP MEMBERS:
MIRZA MOHTASHIM BAIG
KHAWAJA SAAD TARIQ
SALMAN RAZA
RABAIL CHANNA
 Fiscal Policy-Meaning
• The word fisc means ‘state treasury’ and fiscal
policy refers to policy concerning the use of
‘state treasury’ or the govt. finances to achieve
the macroeconomic goals.
• “any decision to change the level, composition
or timing of govt. expenditure or to vary the
burden ,the structure or frequency of the tax
payment is fiscal policy.”
- G.K. Shaw
 Objectives of Fiscal Policy
• It has 2 major objectives:
i. GENERAL obj-. aimed at achieving
macroeconomic goals
ii. SPECIFIC obj-. relating to any typical
problems of an economy
 Fiscal Policy And
Macroeconomic Goals
• Economic Growth: By creating conditions for increase in
savings & investment.
• Employment: By encouraging the use of labour-
absorbing technology
• Stabilization: fight with depressionary trends and
booming (overheating) indications in the economy
• Economic Equality: By reducing the income and wealth
gaps between the rich and poor.
• Price stability: employed to contain inflationary and
deflationary tendencies in the economy.
 Instruments of Fiscal Policy
• Budgetary surplus and deficit
• Government expenditure
• Taxation- direct and indirect
• Public debt
• Deficit financing
 Budgetary surplus and deficit
• “A budget is a detailed plan of operations
for some specific future period”
• Keeping budget balanced (R=E) or deficit
(R<E) or surplus (R>E) as a matter of
policy is itself a fiscal instrument.
• An accumulated deficit over several years
(or centuries) is referred to as the
government debt
 Government Expenditure
 It includes :
• Government spending on the purchase of
goods & services.
• Payment of wages and salaries of
government servants
• Public investment
• Transfer payments
 Taxation
• Meaning : Transfer of private income to
public coffers by means of taxes.
• Classified into
1. Direct taxes- Corporate tax, Div. Distribution
Tax, Personal Income Tax, Fringe Benefit taxes,
Banking Cash Transaction Tax
2. Indirect taxes- Central Sales Tax, Customs,
Service Tax, excise duty.
 Public debt
• Internal borrowings
1. Borrowings from the public by means of treasury bills
and govt. bonds
2. Borrowings from the central bank (monetized deficit
financing)
• External borrowings
1. foreign investments
2. international organizations like World Bank &
IMF
3. market borrowings
FISCAL POLICIES
(1958 - 1969)
 GENERAL PICTURE OF THE
ECONOMY
•Substantial change in the composition of GNP

•Reduction in the difference between the industrial and agricultural sector as compared to the 1950s

•The agricultural sector grew from a mere 1% to 3.7% during the period of 1960-65 due to the “Green Revolution”

•The manufacturing sector recorded a growth rate of 17% in this period

•The industrial sector recorded a growth rate of 10% in the second half of his rule
• Tax incentives given to push the private sector to invest in small time
businesses

• Public sector playing a big role in promoting the manufacturing industry

BRIEF COMPARISON AMONGST
VARIOUS DECADES
Source: Government of Pakistan, Pakistan Economic Survey
 POST WAR 1965 SITUATION
•Decrease in foreign loans inflow, namely from the US

•Pakistan received huge amounts of economic aid from the US before the 1965 war in order to gain support of a pro-west military regime in the cold war period.

•GDP growth rate remained at 6.8% per annum

•The balance of trade deficit was financed by large inflow of funds

•Poor crops in 1966 and 67 meant diversion of foreign exchange to import food grains, increasing the burden of import financing by 8% per annum
Economic and Military Aid by the US throughout the
Ayub Era

Source: U.S. Overseas Loans and Grants [Greenbook] and US Assistance per

Capita by Year
 Why the GDP did not divert
considerably?
• The increase in food import lead to two things:
1.Shift in allocation of resources from capital intensive projects to less capital intensive investments
2.Shift in development strategy from industry to agriculture

•Hence the agriculture sector grew by approximately 5.6 % and the export of manufactured goods on account of investment in
export oriented industries through the export bonus scheme
Third plan and Ayub’s downfall
• Due to resource shortage at the end period of the 1960s, the manufacturing sector
recorded a slow down from a 16% per annum growth rate to 10% per annum growth rate.

• There was an intense rise in the income disparity which eventually led to Ayub Khan’s
downfall, introducing Z.A.Bhutto’s regime
FISCAL POLICY
(1971-1977)
• Public savings were low largely because fiscal deficit
and primary deficit remained at 7.6% and 5.9% of
GDP on average respectively, mainly due to large-scale
investments in public sector, production subsidies and
spending on social program. The huge expansion in
public sector was not matched by the off setting rise in
revenue which remained stagnant, i.e. 14.2 percent of
GDP and subsidies on wheat, fertilizer, plant protection
etc increased. The fiscal deficit was financed mostly
from external sources, i.e. 50.9 percent, from bank
borrowing and non-bank borrowing.
• The current account balance was in deficit of 5.2%
of GDP on average. The deficit resulted from huge
imports; even the boost in the exports as a result
of massive devaluation of 131% in 1972 could not
nullify the impact. However the Government
succeeded in wining the favor of Middle East
countries for accepting Pakistan labor and
consequently restrictions on outward migration of
workers were eased. The workers remittances
enhanced during the decade that helped in
improving the balance of payments position.
• Average investment and saving rate remained at
around annual average of 17.1% and 11.2% of
GDP respectively.

• The high inflation throughout i.e. 12.2% was the

result of high oil prices, increase in remittances,
and enhanced public consumption along with
decreased production output.
 CONCLUSION
• The positive aspects of the period include setting up of basic
industries bringing income redistributions and managing to
send a large number of people to Middle East. The policy
makers tended to correct the excesses of the previous
decades, however increased public expenditures were not
matched by increased resource generation in the form of
public-private savings, increased tax to GDP ratio and
private investment. External sector imbalances were
compensated by increase in remittances and increase in
export earnings was only 9 percent in contrast to increase in
imports of 18.5 percent per annum and the terms of trade
were unfavorable due to rise in oil prices. Thus on the whole
the new strategy did not bring immediate results in terms of
growth rates.
Fiscal Policy
1980’s
• Expansionary Fiscal Policy
• Tax exemption
• Denationalization
• High non-bank borrowing
• Conditional agreement with IMF and World
Bank for SAP
 Fiscal Indicators
% of GDP
Variables 1970s 1980s
GDP(growth) 5.0 7.1
Inflation 12.2 7.6
Saving 11.2 14.8
Investment 17.1 18.7
Budget deficit 7.6 6.8

Current account balance -5.2 -2.8

Revenues 14.3 17.6

Expenditures 21.9 24.3

Overall deficit 7.6 6.8

Source: Economic Survey of Pakistan(Various Issues)

Variables 1970s 1980s
External Financing 50.9 22.6

Domestic financing 49.1 77.4

Bank borrowing 21.2 27.8

Non-bank 28.0 49.6

borrowing

Source: Economic Survey of Pakistan(Various Issues)

 Drawbacks of the policy
•Misuse of tax cut by the land lords
•Procurement by government below
import parity prices
•High non-bank borrowing- increase
in external debt
•Low private investment
 Critical Analysis
•Unstable policy-change from
nationalization to deregulation
•Islamization and Afghan war
•Ignorance to agricultural sector-
backbone of Pakistan’s economy
After Zia Era-Onwards
By: Rabail Channa
PAKISTAN’S CHRONIC FISCAL DEFICIT
Experience has shown that cutting
expenditure has generally yielded better
results than raising taxes.
(Article from Dawn by Naveen Ahmed, Dec
14-1996)
 Deficit financing in Pakistan is very high
and it comes from following Sources:
• Printing new notes
• Foreign loans aid and grants
• Using previous balances
• Borrowing from banks including SBP.
 This research also concluded that the
tight policies that worked were those
based on spending cuts and not those that
tended to rely on higher taxes. In
successful episodes expenditure fell by
2.2% of GDP while taxes rose by a mere
0.4%.
 Comparison

30
25
% of GDP

20
15
10
5
0

Fiscal Years

Total Expenditure(% of GDP) Total revenue from taxes (% of GDP)

Source:http
://www.finance.gov.pk/publications/Fiscal_Policy_State
ment.pdf
• This could prove a valuable lesson for
Pakistan's economic managers. As has been
typical federal budget of 1996, sought to cut
the deficit by raising taxes .

• And so far the most successful debt cutters

have been those who are bold enough not to
raise taxes but rather to cut expenditure.
 Moreover, despite the heavier emphasis on debt as a source of
financing, developing countries have a lower tolerance for
high debt to GDP ratios. Thus management of the long term
cost and sustainability of these flows is of extreme importance.

 The fiscal and real sectors of the economy are strongly linked
to internal and external debt through certain economic
variables. On one hand, it appears that the budget deficit is
the major cause of domestic debt. While, on the other hand, it
turns out that the deficiency in savings and its effects on the
balance of payments is the basis of foreign debt.
• The fiscal status of the federal government has
deteriorated significantly over time from a surplus on
the revenue account to a deficit of over Rs.21 billion in
1990-91.

• On the whole, the overall budgetary deficit has

increased from about 13 billion in 1977-78 to almost
Rs.60 billion in 1990-91.
• STRUCTURAL ADJUSTMENT TO IMF
CONDITIONALITIES The IMF has imposed
conditional ties on GOP in 1988 as part of the
medium-term Structural Adjustment Program.
The basic objective of these conditional ties is to
bring down the size of the budgetary deficit as a
percentage of the GDP.

• The May 1991 NFC award has come after a gap

of 17 years (due since 1974) and some abortive
attempts earlier. Meanwhile the provinces had
run into large, chronic deficits on the revenue
account necessitating the ad-hoc provision of
federal revenue deficit grants.
• In 1997 Nawaz Sharif Launched the National
Debt Retirement Program.
• In January 2000 General Pervez Musharraf
Set up a Debt Reduction Management committee.
• In 2005 Fiscal responsibility & Debt limitation
Act
• In 2008-2009 IMF took the measures to
achieve the fiscal consolidation.

• For tax reform the restructure of FBR

has taken place and establishment of
Inland Revenue Service(IRS).
• Source: http://www.finance.gov.pk/publications/Fiscal
%20Policy_formatted_FINAL.pdf
 Criticism
• Current Expenditure alone exceeds total
revenue

• Development expenditure has been falling,

while current expenditure has grown.
 1980s 1990s 2001/2001

Total Expenditure 24.9 24.1 22.8

Total revenue 17.3 17.1 17.2

Current expenditure 17.6 19.4 19.3

Debt servicing 3.8 6.8 7.2

Defence expenditure 6.5 5.6 4.1

Development 7.3 4.7 3.5

expenditure

Budget deficit 7.1 6.9 5.2

Source: GOP, Pakistan Economic Survey

• Pakistan’s tax system is characterized by a
number of structural problems.
• First, the tax to GDP has remained stagnant at
between 12 or 13%. This is one major why
budget deficits have been high.
• Overdependence on indirect taxes, within
indirect taxes there is domination of taxes on
international trade which has promoted
inefficiency.
• Effective tax bases of most taxes are narrow
due to wide range of exemptions and
concessions and tax evasions.
 Conclusion
• The basic strategy of resource mobilization will
consist of generating the largest component (in
proportionate terms) of additional revenues
from direct taxes like income and wealth tax.
Not only is the revenue-raising potential
highest in these taxes but this will also provide
for a more balanced, progressive and elastic tax
structure.
• Some of the areas of reform in income taxation
include removal of exemptions, taxation of
unearned income, introduction of presumptive
income taxation, minimum taxation on
registered firms and individuals, fixation of
corporate norms and rationalization of tax rates.

• In the case of wealth tax, potential areas of

reform include updating of valuation Lists,
introduction of an agricultural wealth tax and
withholding tax provisions.

• In the case of indirect taxes, cornerstones of the

likely resource mobilization strategy are
extension of excise duty to services and the
general sales tax to wholesale level, broad basing
of customs duties, and improvements in the
system of export rebates.
• Also, greater economy in expenditure will have to be
achieved. This will include, first, the handing back to
the provinces of functions (in the concurrent list) which
had earlier been federalized due to the paucity of
resources at the provincial level.
• Second, winding down ministries performing a role of
coordinating essentially provincial functions,
• Third, adopting a more efficient policy of public debt
management
• Fourth, freezing the real level of defense expenditure.
• Fifth, in the area of social sector investments,
innovative delivery mechanisms will have to be evolved
which are cost effective and involve a greater degree of
community involvement in the choice, execution,
financing and management of services.
THE END