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Fiscal Policy in Pakistan

Fiscal Policy in Pakistan

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Published by: kanwal_bawa on Oct 03, 2011
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Fiscal policy is deliberate changes in government expenditure and income so as to achieve desired economic and social objectives. Keynesian theory states that government can influence macroeconomic productivity levels by increasing or decreasing tax levels and public spending. Fiscal policy is an instrument of economic development that can have major impacts on income distribution and poverty through taxes, public borrowing and public expenditure.

To influence the level of aggregate demand in the economy in an effort to achieve economic objectives of price stability and economic growth To influence the consumption pattern so that economic stability can be maintained. To raise the level of employment Redistribution of income from the rich to the poor.

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Expansion of exports
Control of import of luxury and non-essential goods promotion of investment

The three possible stances of fiscal policy 1. A neutral stance of fiscal policy implies a balanced economy. This results in a large tax revenue. Government spending is fully funded by tax revenue and overall the budget outcome has a neutral effect on the level of economic activity. 2. An expansionary stance of fiscal policy involves government spending exceeding tax revenue.

3. A contractionary fiscal policy occurs when government spending is lower than tax revenue.

 Government  Taxes


Changes in the level, timing and composition of government spending and taxation can have a significant impact on the economy.

Government expenditure This is the expenditure by the central and the local government and any loans or grants to the industries. Divided into 5 main categories – Current expenditure: spending on day to day running of the public services for instance defense. Defense is 24% of current expenditure in fiscal year 2011-12 Development expenditure: spending on the public sector development for instance development of dams, railways, petroleum and natural resources and KESC.

Capital expenditure - spending on the social infrastructure for instance spending on new roads and. Transfer payments - these are payments to pensioners, the unemployed and subsidies to producers. Debt interest - payment to holders of government debt for instance National savings certificate.

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1. 2. 3. 4. 5.   

Taxation Direct taxes These are taxes levied on the income and the wealth of individual and on the profits of companies. Income tax all income is classified under the following heads: Salaries Interest from property Income from business Capital gains Income from other sources Corporate tax Capital gains tax Inheritance tax


Indirect taxes These can be called expenditure or outlay taxes. These are taxes on the spending on goods and services, collected by the Customs and Excise department. Value added tax (VAT) Excise duties Tariffs Other indirect taxes

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DIRECT TAXES FEDERAL GOVERNMENT Income tax Corporation Wealth tax Property tax

INDIRECT TAXES Sales tax Excise tax Import duty export duty Gas, petroleum surcharge. Foreign travel taxes. Stamp duty Motor vehicles Entertainment tax Excise duty Cotton fee Electricity duty.


Land revenue Urban immovable property Tax on transfer of property Agriculture income tax Capital gain tax on land building. Tax on professions, traders and callings

Internal structure of tax has undergone substantial changes. Share of income tax has risen significantly from 31% in 1999-2000 to 39% in 2010 – 11. Main culprit is falling share of customs and excise duties mainly because of tax and tariff reforms. Share of customs has been 12% in both the years.

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Sales tax has become very important consumption tax, it accounts for two-third of indirect taxes.
Reforms are needed to increase the tax to GDP ratio from 10.5% to 13 – 15% during the next 5 years.

Fiscal balance deteriorated in 2009-10. some adjustment is expected in fiscal deficit but it is far off from the target.

Fiscal imbalance widened from 5.3% of GDP in 2008-09 to 6.3% in 2009-10 against the target of 4.9%.
Target for 2010-11 has to be adjusted upward from 4.0% of GDP to 5.3% of GDP. Meeting this target requires massive adjustment in development expenditure and some additional revenue measures. After 2008, revenue to GDP or tax to GDP has either remained stagnant or declined from 14.6% to 14.3% to GDP. Current expenditure was high due to spending on defense and security. Along with subsidies given for energy, food items and cash transfers. Government has decided to limit this expenditure in order to control the deficit in the upcoming year.

Well designed fiscal policy comprises of revenue and expenditure reforms which is always supportive to economic growth. During the last three years expenditure has surpassed the revenue resulting in fiscal deficit. In 2008-09 fiscal deficit declined from 7.6% of GDP to 5.3%. Still not meeting the target of 4.7% of GDP.

In 2009-10, the actual fiscal deficit increases to 6.3% due to lower revenue collection, security spending and electricity subsidies.

Pakistan has undergone substantial changes in last 3 years. Increasing fiscal deficit led to accumulation of huge debt. Domestic debt stock piled up by Rs.803.96 billion in July-March 2010-11. Annual debt servicing payment stood at $6327 million in 2001-02. Now has reached $7.8billion. Out of this amount, $6.2 was paid on account of repayment of principal amounts.

Government debt as a percent of GDP, also known as debt-to-GDP ratio, is the amount of national debt a country has in percentage of its Gross Domestic Product.
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Basically, Government debt is the money owed by the central government to its creditors. There are two types of government debt: net and gross. Gross debt is the accumulation of outstanding government debt which may be in the form of government bonds, credit default swaps, currency swaps, special drawing rights, loans, insurance and pensions. Net debt is the difference between gross debt and the financial assets that government holds. The higher the debt-to-GDP ratio, the less likely the country will pay its debt back, and more likely the country is to default on its debt obligations.

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The Government Debt in Pakistan was last reported at 56.8 percent of the country´s GDP. From 1994 until 2010, Pakistan's average Government Debt to GDP was 70.54 percent

Reaching an historical high of 87.90 percent in December of 2001 and a record low of 54.60 percent in December of 2007.
Generally, Government debt as a percent of GDP is used by investors to measure Pakistan's ability to make future payments on its debt, thus affecting Pakistan's borrowing costs and government bond yields.

Presentation – Part 2

Revenue Trend (Rs. million)

2500000 2000000 1500000 1000000 500000 0 1997 1998 1999 2000 2001 2002 2003 2004 2005 Total Revenue Tax Revenue Non tax revenue






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Total tax revenue consists of federal and provincial tax revenue. Non tax revenue comprises of income from property, receipts from civil administration, state bank profit, royalties and passport fees. An increase in revenue from 2006- 2010 is mainly due to the large public debt our nation is in which needs to be covered. Due to that the government has raised income tax leading to inflation. In the past ten years, the trend in Pakistan regarding tax is such that the tax burden on poor has increased while it has declined on the richest households. In June 1979, income tax act of 1922 was replaced by Income Tax Ordinance 1979. This made no fundamental changes in the system of income taxation. The main aim according to the government was to arrange provisions in a more systematic form. Therefore, a very common problem in analysis on tax responsiveness is due to the frequent changes in policies of tax collection.

Expenditure Trend (Rs.million)
3500000 3000000 2500000 2000000 1500000 1000000 500000 0 1997 1998 1999 2000











Total expenditure


interest payment


One of the principal reasons for the lack of responsiveness of expenditures to changes in revenue is the downward rigidity in major expenditures heads like defense, debt servicing and cost of civil administration. Development expenditure is more difficult to cut back due to the on going development schemes. The emergence of the War on Terror and the resulting rise in security spending along with more recent problem of large subsidies to public sector enterprises and introduction of transfer payments have increased public expenditure by almost three percentage points of the GDP in the last six years. Dr. Abdul Hafeez Shaikh said on 29th May 2011, that the government of Pakistan would reduce its expenditures and would generate more resources by bringing non tax payers into the tax net. This would help to minimize the dependency of foreign help and aid.

Fiscal Balance and Financing ( Rs.million)



fiscal deficit financing


external non bank

0 2000 2001 2002 -500000 2003 2004 2005

banking system sbp 2006 commercial banks 2007 2008 2009 2010 privatisation proceeds


Fiscal record of Pakistan has not been impressive over the last two decades of development. Larger budget deficits have persisted manifesting a lack of proper management of the economy. Persisting fiscal imbalances have undermined the performance of real sectors of the economy, increasing strain on the balance of payments and unleashing inflationary pressures as well. In 2000, fiscal deficit was pursued by 4 sets of measures which made a difference till 2005. These are as followsMobilizing additional tax revenues Reducing subsidies to corporations Controlling defense expenditure Bringing about significant decline in debt servicing.

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The deterioration in budgetary disciplines has also made the economy dependent on large-scale borrowings resulting in everincreasing burden of debt servicing. The key issue with the fiscal deficit remains its financing. A much larger than planned recourse to the domestic credit market to finance the deficit was required in FY2009 as external sources of financing dried up. The trend continued in the first half of FY2010. To this end, in the first 8 months of FY2010, the government borrowed PRs191 billion from commercial banks, although it kept borrowings from the central bank in check. In addition to bank financing, nonbank domestic financing of the deficit is mainly through the National Saving Schemes jumped sharply.

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Domestic and External debt Trend (US$ million)

5000000 4500000 4000000 3500000 3000000 2500000 2000000 1500000 1000000 500000 0 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008

External debt External and Liabilities Domestic debt



Pakistan is using domestic borrowing to pay the foreign debt servicing. The growth of public domestic debt in Pakistan has not been restricted to make sure that the plenty of resources are available after debt servicing to finance government expenditures of various nature. There are several reasons of public domestic debt. First, it is used to finance budget deficit. Second, it is used to implement monetary policy through open market operations.

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Third, there is need to develop and deepen the financial markets by the instruments of domestic debt.
Domestic debt can have severe implications for the economy as well. Domestic debt servicing absorbs a major part of government revenues. So, government has fewer resources to spend on development projects. In this way, internal debt servicing is more harmful for the economic growth than the stock of internal debt. Moreover, in shallow financial markets, as the domestic debt increases, the interest cost also rises due to holding a large amount of debt in short term instruments.

External debt plays both a positive and negative role in shaping economic growth, particularly of the developing countries. External debt is helpful when the government utilizes it for investmentoriented projects such as power, infrastructure and the agricultural sector. On the other hand, it would affect negatively when it is used for private and public consumption purposes, which do not bring any return. Pakistan’s external debt is seen to be the cause of all ills afflicting the economy. External debt increased from $19.200 billion in 1990 to $33.60 billion in 1999 and further to $37.362 billion by 2007. Moreover, in most of the fiscal years since independence, the government’s revenue has been less than its expenditure, which in turn would cause fiscal deficit which could be bridged through borrowing from both internal and external sources (debt). But the situation becomes worse when the country is unable to repay its debt servicing.

Furthermore, after 9/11, the world’s strategic policies changed, and Pakistan became a front-line state in the global war on terror. Pakistan was consequently able either to write off or reschedule the external debt liabilities. The amount of remittances and foreign grants also increased manifold during this period. Pakistan was thus able to repay debt services and interest of the IMF and the World Bank. Moreover, if the government is able to act upon the debt limitation law, which has been passed by parliament, it would be able to get rid of debt owed to both the IMF and the World Bank. However, there remains the need of encouraging sectors like industry and agriculture to meet the fiscal gap.

According to Dr. Muhammad Yaqoob’s article :

1. Public sector saving expenditure gap This is being filled by internal and external borrowing that adds to the debt burden.

Continuous reliance on excessive borrowing to net rising expenditure would be taking the country towards an external debt default.
2. National saving rate

At the macro level, single most important economic problem is that national saving rate is about 1 ½ of the investment requirements of the country to generate a growth rate of 6 to 7%.

3 . Domestic tax revenue  This is about ½ of Total government expenditure and rest of the spending was financed by printing of notes by SBP and generosity of foreign bilateral lenders. 4. Runaway inflation

Moreover, due to burden of debt economy suffers from inflation which is the worse form of taxation, taxing the poor and saving the rich.

5. Government expenditure  Salaries of government employees consumes a higher% of government expenditure along with foreign trips of all types for the president.

1. Government expenditure should be curtailed like foreign trips for the President. 2. A freeze should be put on buildings, cars, and furniture and other non essential items.

3. Development expenditure to be priortised towards electricity generation, irrigation water development and education.
4. Luxury consumption should be taxed more than the essential items of daily use.

5. Reduction in borrowing from the banking system by both federal and provincial government.

6. There should be substantial lowering of government borrowing from abroad. 7. Exports should be exempted from taxation

8. Luxury imports should be subjected to higher tax rate.
9. Service sector and agricultural sector should be brought under the income tax regime.

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