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2012

FEDERAL BUDGET
Of Pakistan

January 1, 2012

FEDERAL BUDGET

Article Title:

Federal Budget of Pakistan

Submitted By: Kashif Abbas
Roll Number: Section: Semester: 38 A 5th

Business Administration Federal Urdu University of Arts, Science and Technology.
Email: qashee@ymail.com

Submitted To: Sir. Faseeh Ulah Khan
Faculty: Economics of Pakistan Federal Urdu University of Arts, Science and Technology.

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Abstract
The plan of the paper is as follows: the budget is prepared at the backdrop of prevailing domestic and external economic challenges therefore a discussion on these developments is presented in Section-II. Is this budget different from the past? The answer is presented in Section-III. The main objectives of the budget are documented in Section-IV. Salient features of the budget are presented in Section-V. The new National Finance Commission (NFC) Award forms the basis of revenue sharing between the federal and provincial governments on the one hand and within the federating units on the other. The sharing of federal revenue receipts with provinces is presented in Section-VI. While the objectives of the budget are set out in Section-IV, how the budget is going to achieve these objectives are discussed in Section-VII. The risks attached with the budget are discussed in Section-VIII while the final section contains the concluding remarks. Key Terms: Budget, Federal Budget, Budget 2011-2012.

Introduction
The newly appointed Finance Minister Senator Dr. Abdul HafeezShaikh has presented his first and this government’s third federal budget (2010-11) in the National Assembly on June 5, 2010. An attempt is made in this paper to provide a concise and objective overview of the Federal Budget 2010-11 with a view to assisting the Members of the Parliament in understanding the budget and making the budget debate more meaningful, productive and constructive. Budget is an estimate of revenue and expenditure for a future period as opposed to an account which records financial transaction. Budget is an essential element in the planning and control of the financial affairs of a country. It is a complex document that takes several months to prepare. The federal budget sets out the estimates of the federal government’s expenditures and revenues for the fiscal year and is normally presented by the Ministry of Finance to the National Assembly. The Finance Minister reviews economic conditions of the country and makes forecasts for the revenue and expenditures for the coming year and announces proposed changes in taxation. These changes normally becomes effective immediately, but are subject to parliament debate and approval in the Finance Bill. With the increasing importance of government expenditure and resource utilization and mobilization, the annual is an important instrument in government’s economic policy making to address the prevailing economic challenges. Domestic economic challenges and external economic environment play important roles in shaping and designing the country's budget. Pakistan's economy is current facing multi-dimensional challenges including declining investment and slowing economic growth; rising unemployment and poverty; growing revenueexpenditure gap (budget deficit) and mounting debt burden; depreciating exchange rate and persisting doubledigit inflation; crumbling public sector enterprises (PSEs) putting severe strains on national exchequers; mismanaging power sector and waning confidence of the private sector. Investment is a key determinant of economic growth. Investment as percentage of GDP is continuously on the decline from a peak of 22.5 percent in 2006-07 to 16.1 percent in 2009-10 -- a decline of 6.4 percentage points in the last three years. Deteriorating 3

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security environment, heightened political tension, power mismanagement, poor governance and inconsistency in economic policies are mainly responsible for the sharp decline investment. Declining investment has also slowed the pace of economic activity. Economic growth slowed from an average of 7.0 percent per annum during 2002-07 to 3.0 percent during 2008-10. Decelerating economic growth shrinks the capacity of the economy to create jobs, thus giving rise to unemployment and poverty. Unemployment is up from 5.2 percent in 2006-07 to 5.5 percent in 2008-09 (last number available). When people remain unemployed for a longer duration, they fall below the poverty line and hence poverty increases. Accordingly, all available information suggests that poverty in Pakistan is on the rise. The Budget 2010-11 must arrest the declining trend in investment, set the stage for economic recovery, job creation and poverty alleviation. Persistence of large budget deficit, senseless and indiscriminate borrowing, and sharp depreciation of exchange rate has caused irreparable damage to the economy of Pakistan. Higher debt burden is a major threat to macroeconomic stability. Public debt almost doubled in just three years, rising from Rs.4.8 trillion in 2006-07 to close to Rs.9.0 trillion in 2009-10. Higher public debt means more interest payments and less resource available for development purposes. Interest payment was Rs.387 billion in 2006-07 but almost doubled (Rs.700 billion) in just three years, leaving relatively less resources for investing in physical and human infrastructure. Budget 2010-11 must arrest the rising trend in public debt by reducing budget deficit and maintaining stability in exchange rate. Persistence of double-digit inflation for the last three years has inexplicably hurt the poor and fixed income groups, created uncertainty throughout the economy and undermined macroeconomic policies. Higher inflation always burdens the poor and fixed income groups more than the rich since they are unable to protect themselves against the costs attached to inflation, nor able to hedge against the risks that inflation brings with it. Budget 2010-11 must address the issue of inflation and protect the poor and fixed income groups by providing them relief. Pakistan's PSEs, most notably the PEPCO, PIA, Railways, Pakistan Steel, PASSCO, TCP, NHA, and Utility Stores Corporation (SC) are inefficient, poorly managed, bleeding profusely and as such have emerged as a serious burden to the national exchequer. The government has injected Rs.245 billion of the tax payer's money in these enterprises in 2009-10 to keep them afloat. The government has treated these PSEs as sources of providing unproductive jobs to its favourites. How long the tax payers of this country could finance the inefficiencies and corruption of these enterprises? When government try to do what the private sector can do as well and can do even better, the state's managerial and financial resources are diverted from essential services that only the state can provide equitably to all its citizens -- education, health, and roads among others. Budget 2010-11 must address the issue of poorly managed PSEs. It has to choose between the restructuring of PSEs and making them financially solvent and privatizing them as part of structural reform to infuse the whole economy with competitive market forces. Shortage of electricity has emerged as a major constraint to industrial growth. Power conservation and augmentation should be the priority of the government in the short-to-medium-to-long-run. Budget 2010-11 must allocate sufficient resources to augment supplies of power in the short-to-medium term. As will be seen in the ensuing pages, the Budget 2010-11 has been prepared to address the above-listed domestic economic challenges. The world economy is emerging from the worst recessionsince the World War-II. Economic recovery around the world is not only uneven but still fragile. The emergence of Greek debt crises since April 2010 and the spread of such crises to other Euro zone countries like Spain, Portugal have enhanced the risk associated with global economic recovery. These crises have implications for the budget in terms of less-than-satisfactory availability of external resources for financing budget deficit. 4

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Pakistan has been at the epicentre of the global “War on Terror” since 9/11. It has suffered immensely in terms of loss of income. One estimate suggests that the estimated loss to the economy is in the neighbourhood of $ 35 billion which has now increased to $ 43 billion. The war on terror has budgetary implications as the government will have to allocate substantial resources to fight the war. Budget 2010-11 has allocated adequate resources to fight this war. Budget 2010-11 has been prepared at the back of the developments listed above. Domestic economic challenges may restrain government to generate adequate resources. External economic environment may affect the inflows of external resources to finance budget deficit and war on terror would be receiving adequate funding from the budget.

Explanations
Budget with a Difference:
Budget 2010-11 is different from the previous two budgets of the present government in several respects. Firstly, the budget speech of the Finance Minister itself was different from the past. More than half of his speech was extempore, reflecting his confidence in the budget. No Finance Minister has ever moved an inch away from the written text of the budget speech. Finance Minister also gave an economics 101 lecture to his fellow Parliamentarians, explaining them the concepts of inflation and its consequences for the poor and fixed income groups; the burden of public debt and its implications for the economy; and the crowding out phenomenon. The Finance Minister was bold in acknowledging the many failures of his government in the last two years and expressed his determination to address the challenges facing the economy. The Minister was highly critical about the pathetic state of public sector enterprises (PSEs) and the damage they have caused to the economy. In so doing, he criticized his own government in treating these enterprises as sources of unproductive employment. The Minister also criticized his predecessor for “indiscriminate borrowing” and doubling public debt in a short span of time. Secondly, the Budget 2010-11 is the first budget under the new NFC Award and as such posing difficulties for many analysts, experts, commentators, trade bodies and other segments of societies in understanding the budget. Thirdly, under the new NFC Award, the provinces will be receiving more than one-half (56%) of the federal revenue receipts. Thus, more resources mean more responsibilities and more money for education, health, law and order, drinking water and municipal services. Correspondingly this means reduced fiscal space for the federal government and accordingly less resource for social sector. The federal government role would generally be limited to tertiary levels of education and health with major responsibility for social sectors shifting to the provinces. Fourthly, this budget is prepared in the framework of international commitments. It is important that Pakistan as a sovereign nation fulfil its commitments and do not erode its credibility. Not fulfilling the international commitments will have serious consequences for external inflows.

Objectives of Federal Budget 2010-11:
The first and foremost objective of the budget is to stabilize the economy because macroeconomic stability is a precondition to generate growth momentum. No country can achieve higher economic growth on a sustained basis without achieving and consolidating macroeconomic stability. The government is using budget (fiscal polity) as one of the many instruments to achieve stability. Reduction in fiscal deficit, bringing inflation down to a single digit level, reducing deficit in external account, and maintaining stability in exchange rate are the principal elements of macroeconomic stability. 5

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The government has targeted to reduce budget deficit at 4 percent of GDP (or Rs.685 billion) in 2010-11 -- down from 5.3 percent (or Rs. 783 billion) last year. Deficit in external account and inflation are targeted at 2.5 percent of GDP and 9.5 percent, respectively. Reduction in “twin deficits” (budget and current account deficits) would help reduce the government's borrowing requirement and hence slow the pace of debt accumulation which will in turn, reduce the country's debt burden. Stabilization measures entail cost to the poor and the fixed income groups. The Budget 2010-11 has taken various measures to protect the poor and fixed income groups from the adjustment cost which forms thesecond objective of the Budget. Reducing inflation is the third objective of the Budget. High inflation disproportionately hurts the poor and fixed income groups more. The best relief that this Budget can provide to these segments of the society is to do whatever it is possible to reduce inflation. Pakistan's PSEs, particularly the PEPCO, PIA, Railways, Pakistan Steel, PASSCO, TCP, NHA and Utility Stores Corporation (USC) are inefficient, poorly managed and are a burden to the national exchequer. The government has injected Rs.180 billion alone in power sector enterprises in the outgoing fiscal year (2009-10) while the remaining seven PSEs added additional cost of Rs.65 billion to the exchequer. Such a large sum of Rs.245 billion not only destabilized the budget but held the economy of Pakistan hostage. It also leaves little resources for development expenditure. This is yet another objective of the Budget 2010-11 to address the issue with some urgency. Further bail out of these enterprises has been linked with restructuring and making them financially solvent. The fifth objective of the Budget is to improve investment environment in the country. Improving competitiveness by reducing cost of doing business and making private sector as engine of growth is the objective of the budget. Energy and food security are the sixth objective of the Budget. Energy has emerged as a major constraint to growth in general and industrial growth in particular. A deep structural reform will be undertaken in 2010-11. To augment power supplies and improve the distribution network, adequate resources are earmarked for energy sector. Similarly, to improve water availability for irrigation purpose with a view to enhancing food production, the Budget 2010-11 provides sufficient resources to the agricultural sector.

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Salient Features of the Budget:
The total outlay of Budget 2010 – 11 is estimated at Rs. 2,764 billion which is 12.3% higher than the size of the outlay of last year's budget (see Table I). Tax revenue is estimated at Rs. 1,779 billion which is 20% higher than last year. Within tax revenue, the Federal Board of Revenue (FBR) collection amounts to Rs. 1,667 billion which is estimated to be higher by 20.8% over the last year (Rs. 1,380 billion)(see Table II). Direct tax to be collected by FBR is estimated at Rs. 658 billion – up by 21.9% over last year. On the other hand, the indirect taxes which include customs, sales tax, and federal excise duty are estimated at Rs. 1,009 billion which is 20% higher than that of last year (Rs. 840 billion). The shares of direct and indirect taxes to FBR collection stand at 39.5% and 60.5% respectively as compared to 39.1% and 60.9% in the last year. Within indirect taxes, sales tax accounts for two-thirds and the remaining one-third collection represents customs and federal excise duty. Non-tax revenue in Budget 2010 – 11 is estimated at Rs. 632 billion as against Rs. 569 billion in the last year, thus depicting an increase of 11.1%. By adding tax and non-tax revenue, the total revenue for the federal government amounts to Rs. 2,411 billion. Adjusting for provincial share of Rs. 1,034 billion, the net federal receipts amount to Rs. 1,377 billion (see Table I). Net capital receipts consists of recovery of loans from provincial governments and public sector enterprises, non-bank borrowing (through NSS, prize bond, sukuk) and disbursement to PSEs amount to Rs. 325 billion. Financing of public sector development program by provinces through their own resources amounts to Rs. 342 billion (see Table I). Provincial governments are targeted to generate a cash balance surplus to the tune of Rs. 167 billion or 1.0 % of GDP. Finally, bank borrowing in the fiscal year 2010 – 11 is estimated at Rs. 167 billion. Thus, the total resources of the federal government are estimated at Rs. 2,764 billion. 8

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On the other hand, the current expenditure of the federal government is estimated at Rs. 1,998 billion while total development expenditure stands at Rs. 787 billion, of which, total public sector development program (PSDP) amounts to Rs. 663 billion. Of the total PSDP, the federal component amounts to Rs. 290 billion (this includes Rs 10 billion for ERRA) while the remaining Rs. 373 billion represents the provincial PSDP. Other development expenditure consisting of Benazir Income Support Program (BISP) and InternallyDisplaced People (IDPs) and a few others amount to Rs. 124 billion, thus taking the size of the development expenditure to Rs. 787 billion. Assuming an operational shortfall of Rs. 20 billion, the total expenditure is estimated at Rs. 2,764 billion, thus balancing the resources and expenditures. A cursory look at Table II is sufficient to see that the budget deficit of the federal government is estimated to be Rs. 853 billion or 5% of GDP against the overall fiscal deficit target set in the budget 2010 – 11 of 4% of GDP. In order to achieve the overall fiscal deficit target of 4% of GDP or Rs. 685 billion for 2010 – 11, the provincial governments are required to generate a surplus of Rs. 167 billion or 1% of GDP. Any failure of the provincial governments to generate this surplus would result in breaching the overall budget deficit target for the year. The budget also provides sources of financing overall fiscal deficit to the tune of Rs. 685 billion. Financing from external sources is estimated at Rs. 186 billion while the remaining (Rs. 499 billion) is to come from domestic sources, of which, bank and non-bank financing are slated at Rs. 167 billion and Rs. 332 billion respectively (see Table II for details). Within the federal component of the PSDP, the bulk of resources have been earmarked for improving the country's physical infrastructure. Power and water sector will be receiving Rs. 130 billion and Rs. 28.4 billion, respectively while National Highway Authority (NHA) is projected to receive Rs. 44.6 billion. These three sectors together are projected to receive Rs. 203 billion which is almost three-fourth of the total federal PSDP. Health and education being the provincial subjects, the federal budget allocates Rs. 21 billion and Rs. 17 billion for these two sectors in the federal PSDP. Food and agriculture will be receiving Rs. 11 billion from the federal PSDP for the year 2010 – 11.

Provincial Share in Federal Revenue Receipts:
Federal budget 2010-11 has been prepared under the NFC Award, 2010. The divisible pool taxes consist of the following taxes levied and collected by the federal government in a given year. These include: i. ii. iii. iv. v. vi. vii. viii. Taxes on income Wealth tax Capital value tax Taxes on sales and purchase of goods Export duty on cotton Customs duty Federal excise duties excluding the excise duty ongas charged at well-head and Any other tax which may be levied by the federal government.

Under the NFC Award 2010, 1.0 % of the net proceeds of the divisible pool taxes is assigned to the government of Khyber Pakhtunkhwa province to meet the expenses on war on terror. After deducting the collection charges of 1.0 % the net proceeds of the divisible pool taxes is distributed between the provinces and federal government according to the formula documented in Table IV. Under the new NFC Award, the provincial government will be receiving 56% share in 2010 – 11 and 57.5% share from 2011 – 12 onwards until the next 9

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NFC Award. Accordingly, the federal government will receive 44% and 42.5% respectively. Thus, for the first time in the history of Pakistan, majority of resources collected by the federal government will be going to provincial governments. Within the provincial shares, the respective provincial governments will be receiving their respective shares according to the formula documented in Table IV. On the basis of the respective shares of the provincial governments, they will be receiving Rs. 1,034 billion in fiscal year 2010 – 11 which is almost 58% higher than last year (Rs. 655 billion). The government of Punjab will receive Rs. 494.3 billion which is 49% higher than last year (Rs. 331.6 billion). Sindh is projected to receive Rs. 279.6 billion as against 199.3 billion last year, depicting an increase of 40.3%. The province of Khyber Pakhtunkhwa is expected to get Rs. 160.4 billion as against Rs. 88.9 billion last year, thus showing an increase of 80.4% (see Table IV for details). The largest increase in resource transfer pertains to the province of Baluchistan which will be receiving Rs. 99.4 billion as against Rs. 35.5 billion last year translated into an increase of almost 180%. It is expected that the provincial governments will be spending bulk of their resources on the people of their respective provinces particularly, on education, health, and drinking water, improving their physical infrastructure and municipal services.

How Budget is going to achieve the objectives?
Section IV of the paper has documented the objectives of the Budget 2010 – 11. How these objectives can be achieved are discussed in the current section. The principle objective of the budget as described in section IV is to restore macroeconomic stability. In order to achieve this objective, Budget 2010 – 11 has targeted a budget deficit of 4% of GDP – down from 5.3% last year. By reducing budget deficit, the government is aiming to restore macroeconomic stability which is a pre-condition for generating growth momentum. Reduction in budget deficit will reduce the borrowing requirements; it will ease pressure on interest rate; the SBP may be able to reduce discount rate and the private sector will get more credit as the government's borrowing requirement is reduced; this will help in bringing the interest rates down, thus reducing the overall cost of capital and encouraging private sector to come forward and play its dominant role; higher investment will help generate growth momentum and create employment opportunities. The reduction in the government's borrowing requirement will also help in reducing inflation. The second objective of the budget has been to protect the poor and the fixed income groups. As far as protecting poor is concerned, the budget has provided several reliefs to this segment of society. The relief includes: i. ii. iii. Allocation to BISP rose to Rs. 50 billion which will benefit 5 million poor households. Minimum wage of workers increased from Rs. 6,000 to Rs. 7,000. Pilot program for provision of 100 days of guaranteed employment to rural unskilled labourers is to be launched in 120 union councils of 12 districts which are least developed and suffered with conflict / insurgency. Relief from bait-ul-maal to continue for which an allocation of Rs. 2.16 billion has been made. Under the exit strategy from BISP, one family member of the recipient family is to be provided necessary skills to get gainful employment. Training is to be provided to about half a million people which will be doubled in subsequent years. 10

iv. v.

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vii.

The government is giving ownership to workers in state owned enterprises (SOE) under the Benazir Employees' Stock Option Scheme. Under this scheme, 12% shares have been given to the workers in SOEs. vii. National internship program for young unemployed post-graduate for a period of one year continues. A monthly stipend of Rs. 10,000 is being paid. More than 27,000 interns have benefitted last year and more will benefit in 2010 – 11 for which an allocation of Rs. 3.6 billion has been earmarked.

The budget also provides relief to the fixed income group which includes: i. ii. iii. iv. v. vi. vii. viii. ix. x. Raising the salaries of the government servants by 50%. Doubling the medical allowance for BPS 1 – 15. Raising medical allowance for BPS 16 – 22 by 15%. Increasing pension by 20% and 15% for those who retired before 2001 and after 2001 respectively. Minimum pension has also been raised from Rs. 2,000 to Rs. 3,000 and rates of the family pension are up from 50% – 75%. Night duty allowance for assistants / clerks rose from Rs. 10 / night to Rs. 40 / night. Same allowances for driver and naib-qasid increased from Rs. 5 to Rs. 25 / night. Conveyance allowance for late sittings raised to Rs. 50 / day for BPS 1 – 16 and on holidays, the rate will be Rs. 75 / day. Special pay to stenographers and steno typists are doubled. Daily allowance on outstation duties are being raised by 50% to 100% for BPS 1 – 16.

The third objective of the budget has been to restructure the eight inefficient and poorly managed PSEs. Restructuring of these PSEs will be undertaken in 2010 – 11 to make them financially solvent. The fourth objective of the budget has been to attain energy and food security. Following measures are being taken to enhance the supply of energy and improve its distribution network. These measures include: i. ii. iii. iv. v. Through energy conservation program, the government has saved nearly 1,000 MW of electricity which has brought some relief to domestic consumers. Diversion of natural gas to power plants to improve their efficiency. Free distribution of 30 million energy savers. An energy development fund is being established in consultation with ADB with seed money of Rs. 20 billion. An allocation of Rs. 131 billion is made in budget 2010-11 for hydel, thermal, and nuclear energy projects to augment generation and improve transmission.

On providing food security, the budget 2010 – 11 envisages the following measures: i. ii. iii. iv. Emphasis on development of agriculture and water resources. Efforts to enhance productivity through efficient water and input utilization and better marketing strategy. Food security must come with the mean to purchase food by the poor. Raising of Mangla Dam, GomalZum Dam, and Sudpara Dam would be completed in 2010 – 11. This will substantially add to the availability of water.

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Diamir – Bhasha Dam will be launched as a mega project in 2010-11 which would generate 4,500 MW electricity and store 6,450 MAF water. For attaining food security, the combined budgeted allocation in development budget 2010-11 for water, food, and agriculture, live-stock and dairy development sectors is in excess of Rs. 40 billion.

Risks to the Budget:
While the budget 2010 – 11 has taken some bold measures to enhance revenue, rationalize expenditure and reduce budget deficit, there are nevertheless several risks attached to the next year's budget. How smooth the transition from GST to VAT will take place on October 01, 2010 is the firstrisk. Given the limited time available (3 months), it appears that the transition may not be smooth and hence the revenue target, as set out for the FBR, may not be achievable. Secondly, the FBR revenue target for 2010 – 11 appears, nevertheless, ambitious. It is expected that this year's tax collection will not be more than Rs. 1,325 billion.Assuming a growth rate of 14.5% (a bit ambitious), the autonomous increase in revenue would be Rs. 1,517 billion. Additional revenue through various tax measures as suggested in Budget 2010 – 11, may fetch another Rs. 50 – 60 billion. Thus the total tax collection by FBR may stand between Rs. 1,567 – 1,577 billion in 2010 – 11, thus giving a shortfall of Rs. 90 – 100 billion. Slippages in the current expenditures are also not unavoidable. Furthermore, in order to achieve a overall budget deficit target of 4% of GDP, the federal government expects provinces to generate surplus to the extent of Rs. 167 billion or 1.0 % of GDP. Can the provincial governments generate surplus given their recent performance? The province of Sindh has already presented a deficit budget to the tune of Rs. 25 billion. The other provinces may follow the suit. Given the environment and the mood of the provincial governments, achieving the fiscal deficit of 4% of GDP may not be possible. Finally, under the new NFC award, bulk of resources is to be transferred to provinces with much greater responsibilities which is a positive development. However, there is a risk that the infrastructure in provinces to spend such a large amount may not be enough.

Conclusion
Finance Minister and his team deserve appreciation for presenting a budget in a most difficult and challenging time. Given the prevailing economic challenges facing the country, this was the only way forward. Arguably, this budget is not a populist budget and may have disappointed many people in this country. The prevailing economic situation does not allow the government to take populist measures. The Budget 2010 – 11 can therefore be regarded as a stabilization budget with a human face and reform agenda. The revenue target is ambitious but can be achieved provided the economic team headed by the finance minister receives constant support of the Prime Minister and provincial governments. Thus, the onus for achieving budgetary targets not only rest with the finance ministry but also with provincial governments and the Prime Minister.

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Resources
www.finance.gov.pk “The politics of budget and the new finance minister” “Public terms budget disappointing” “Political parties gauge new fiscal budget” “Hafeez Sheikh defends new budget” “Federal Budget 2010-11: Businessmen confused over vague budget” “Pakistan's working class a reason to exhale”

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