Submitted To:

Mám Tehreem
Subject:
Fiscal Policy
Course:
BS Economics (2016-2020)
Name:
Zainab
Roll No
79
 Fiscal situation of Pakistan.
In July 2019, Pakistan entered into a 39-month Extended Fund Facility (EFF)
arrangement with the International Monetary Fund.  Stabilization measures under
the EFF were expected to moderate aggregate demand pressures in the economy.
Leading indicators suggested a slowdown in growth in the first 7-8 months of
FY20. The output of large-scale manufacturing (which accounts for around 50
percent of industrial output) contracted by 3.4 percent in Jul-Jan FY20. The
agriculture sector, however, registered growth in the rice and livestock sub-sectors.
However, the rapid spread of the COVID-19 virus since February 2020 has
brought economic activity to a near-halt. Most of the country has been placed
under a partial lockdown.  The closure of non-essential businesses and domestic
supply chain disruptions are having a significant impact on wholesale and retail
trade and transport, storage and communication, the largest sub-sectors of the
services sector. The drop in domestic and global demand is also compounding the
strains on the industrial sector, which is hit by both supply and demand shocks. In
addition, the country’s main industrial sector – textiles and apparel – is highly
exposed to COVID-19-related disruptions due to its labor-intensity.
Average inflation increased to 11.8 percent during Jul-Mar FY20 (from 6.8 percent
in Jul-Mar FY19) reflecting upward adjustments in administrated prices and
exchange rate depreciation pass-through. The State Bank of Pakistan (SBP)
maintained a tight monetary stance during this period, keeping the policy rate at
13.25 percent to dampen inflationary expectations. However, as the COVID-19
pandemic spread, it reduced the policy rate to 11.0 percent in March 2020.
The Current Account Deficit (CAD) narrowed to 1.0 percent of GDP in Jul-Feb
FY20, from 3.5 percent in the same period in FY19, thanks to a 17.5 percent
decline in goods imports. This, together with large multilateral disbursements and
higher foreign investment flows, helped shore up gross international reserves to
US$13.2 billion (as of March 27th, 2020)—or equivalent to 3.5 months of imports.
However, due to global developments, foreign investors have offloaded more than
half of their position in domestic securities since February 2020. The exchange
rate, which had remained relatively stable through June-February FY20,
depreciated by 7.3 percent in March.
Forward-looking estimates for FY 2020 (July 2019 to June 2020) showed the
economy slowed significantly, as the coronavirus outbreak weigh heavily on
activity. Economic growth is set to fall to a multi-decade low as private
consumption shrinks considerably amid widespread containment measures from
March onwards. Recent data corroborates the overall estimate, with exports
halving in April amid slackening demand for Pakistani products, while markedly
lower imports point to reduced domestic demand. However, remittances held up
well in the same month, despite difficulties in major economies around the world.
In other news, Moody’s placed its B3 rating under review for downgrade due to
growing concerns about the serviceability of Pakistan’s private-sector debt
obligations amid severe economic and financial shocks.
 The UN projects Pakistan’s economy to grow by estimated at 3.3 per cent for
2019-20, is projected to slip to 2.1 per cent next year, while Indian economy will
grow by 5.7 per cent in the current fiscal year and expects it to rise to 6.6 per cent
in the next.
Export growth has fallen to 0.4 per cent owing to disappointing sales of textiles,
which constitute 60 per cent of the country’s goods exports. GDP growth has
remained weak at 3.3 per cent in both 2018 and 2019—well below the 4–6 per cent
range of previous years. Nevertheless, the economy of Pakistan is expected to
recover slightly from 2021 onward as increased government revenues from a tax
hike allow expanded public investment and as other government reforms required
by the IMF begin to bear fruit. In 2021 the economy is projected to grow by 3.3pc.
Continued commitment to reform, combined with productive investment in
infrastructure and strategic capacity development, will be critical for the country to
find its way back to its previous growth path.
Real GDP growth is projected to contract by 1.3 percent in FY20 as domestic and
global economic activity slows down sharply in the last four months of the fiscal
year. The outbreak of COVID-19 will impact growth beyond FY20. Under the
baseline scenario, growth will remain muted in FY21 before reaching 3.2 percent
in FY22. Inflation is expected to average 11.8 percent in FY20 and to gradually
decline thereafter.
Growth is set to return in FY 2021, as domestic demand expands following the
pandemic-influenced downturn in FY 2020. However, uncertainty regarding the
full extent of the pandemic poses significant downside risks to the outlook, with
the impact on the external sector and debt levels particular areas of concern. Our
panelists see growth of 2.4% in FY 2021, which is down 0.5 percentage points
from last month’s estimate, and 4.1% in FY 2022.
The current account deficit is projected to narrow to 1.9 percent in FY20, as
imports contract more than exports. Export growth is expected to remain negative
in FY21 but to subsequently rebound. Similarly, imports are expected to recover
slowly from FY22 onwards, as domestic industrial activities pick up. Remittances
are expected to contract in FY20 and FY21, respectively, due to lower growth in
the Gulf Cooperation Council economies. Increased multilateral and bilateral flows
are expected to be the main financing sources over the medium-term.
The fiscal deficit is expected to remain elevated in FY20 and FY21.  Revenue
mobilization efforts will be negatively impacted by subdued domestic activity,
while expenditures will increase to contain the spread of COVID-19 and support
the economy. The fiscal deficit is expected to fall gradually by FY22 as the impact
of the crisis tapers-off. However, the public debt-to-GDP ratio is expected to
increase and remain elevated over the medium-term, with Pakistan’s exposure to
debt-related shocks remaining high.
Meanwhile, the State Bank of Pakistan is balancing a stronger commitment to
inflation targeting with a managed depreciation of the currency, but this is
complicated by increases in energy tariffs that have been imposed as part of the
fiscal reform package.
Deficit Financing in Pakistan
.When a government spends more than what it currently receives in the form of
taxes and fees during a fiscal year; it runs in to a deficit budget. When the budget
deficit is financed by borrowing from the public and banks, it is called deficit
financing. Deficit financing refers to the borrowing undertaken by the government
to make up for the revenue shortfall. It is the best stimulant for the economy in
short term. However, in the long term it becomes a drag on the economy and
becomes the reason for rise in interest rate.
.Deficit financing is an important source of capital formation in the developed and
under developed countries of the world. In advanced countries, the newly created
money is used to finance public investments which increase economic growth. The
government invests borrowed money in improving the quality and reliability of
infrastructure i, e, railways, roads, air service, social overheads such as schools.
hospitals etc. The deficit financing is mostly employed to boost up economic
activity in the private sector, raising effective demand for goods and services,
increasing employment opportunities etc,. .In developing countries, the
governments are faced with persistent deficits in the budgets.
Following are the sources of deficit financing in Pakistan:
1. Printing new currency notes
2. Public borrowings
3. Foreign loans, aid and grants
4. Using previous balances
5. Borrowings from banks including from the central bank.
Dr. Mahboobul Haq defines deficit financing in the following words:
(i)Net borrowings by the government from the banking system which
includes the State Bank of Pakistan (SBP) and commercial banks but
excludes non-banking institutions and individuals
(ii)Net borrowings by the Government from the SBP only. But the
public debt does not only constitute the above sources, it also includes
money lent to Government out of the balances of the banks which would
have been held if the Government had not borrowed them. Deficit
financing is a sound and necessary instrument of the Government
finance and its role, its desirability and limitations of its use in
mobilising revenue, must be properly analyzed in the context of its
broad implications on the economy and compared to the adequacy of
other techniques of resource mobilization.

What is fiscal Policy

Fiscal policy is the use of government spending and taxation to influence the
economy. Governments use fiscal policy to influence the level of aggregate
demand in the economy in an effort to achieve the economic objectives of price
stability, full employment, and economic growth.The government possesses two
major fiscal tools to influence the economy. These tools can be divided into
spending tools and revenue tools.
Government Spending Tools
 Capital Expenditure
Capital expenditure refers to what the government spends on amenities such as
schools, roads, and hospitals. This spending adds to a country’s capital stock and
also affects the productivity capabilities of the country. Moreover, as the
government increases its spending on such facilities, it increases the capital stock
of the country. Since such facilities highly encourage investment, the total
productivity of a country also increases due to an increase in investments.

 Current Government Spending

Current government spending includes goods and services which it provides

regularly and on a recurring basis. Such services include defense, health, and
education. Consequently, this is aimed at improving the country’s labor
productivity.

 Transfer Payments

Transfer payments are payments that are made by the government through the
social security systems. Transfer payments ensure a minimum level of income for
low-income individuals. Also, they provide ways in which the government can
change the distribution of income in the society. Therefore, they comprise
unemployment benefits and child benefits. Such benefits also include state
pensions, housing benefits, income support, and tax credits. It should be stated that
such payments are not included in calculating the GDP because they are not
attached to any factor of production .

Government Revenue Tools

 Indirect Taxes

Indirect taxes refer to taxes spent on specific goods like cigarettes, alcohol and
fuel, and services like VAT. Health and education can be excluded from indirect
taxes.

 Direct Taxes

Levies on profits, incomes, and wealth are direct taxes. Taxes charged on a
deceased property can both raise revenue and distribute wealth. They include
capital gains taxes, national insurance taxes, and other corporate taxes.
Taxes and Obstacles in collection of Taxes.

Increasing tax revenues has proven to be a significant challenge for recent

Pakistani governments. The stagnation of the tax to GDP ratio to around 10 percent
has widely been attributed to a host of inter-connected factors including weak
enforcement, fragmented revenue administrations, low compliance by taxpayers,
generous and distortionary exemptions and concessions to entire sectors of the
economy and narrow tax bases.

I. Introduction
Although the tax to GDP ratio has risen over the last three years from 8.45 percent
to 10.5 percent, Pakistan significantly lags below other countries with comparable
levels of income. The country’s tax capacity—the maximum level of revenue that a
country can collect— is estimated to be 22.3 percent of GDP, which implies a
revenue gap of around of 11.8 percent of GDP.
II. Tax Compliance and Potential
Around 7 million out of an estimated total population of around 202 million
Pakistanis are estimated to be eligible to pay income tax, but only around one-tenth
do. Approximately, 2 percent of the total population or 60 percent of the potential
tax base is registered for income tax. However, in tax year 2015, only 0.45 percent
of the total population filed a tax return, corresponding to 15pc of the potential tax
base. Only two thirds of those registered—constituting just above 0.3 percent of
the population—actually paid income tax as part of the tax-filing and assessment
regime. This is one of the lowest ratios in the world. Less than a tenth of taxpayers
paid more than 500,000 rupees in personal income tax for the year (US$4,800
plus). The bulk of the income tax collection is from the corporate sector, which
contributed over two thirds of total income tax receipts in 2015-16, while personal
income tax receipts made up the remainder. Out of over 65,000 companies
registered with the Securities & Exchange Commission of Pakistan, around 25,000
filed a tax return (approximately 38 percent of the total). Of these, 40 percent did
not declare a profit. One percent of all companies accounted for 79 percent of
corporate income tax collection. A similar pattern is borne out in sales tax, which
is a value added tax charged on the sale of goods: out of 1.4 million retailers and
3.5 million commercial and industrial electricity users, only 178,190 are registered
for sales tax.
A. Challenge Facing the Government’s Policy-makers
While on the one hand the above statistics paint a picture far from satisfactory with
regards to compliance by taxpayers and resource mobilization by the government,
on the other they demonstrate the vast potential for increasing tax revenues. The
gap between present tax collection and the capacity of the economy to pay taxes is
even greater when the fact that major sectors of the economy are presently exempt
or nominally taxed by Federal and Provincial Governments is taken into account.
B. Underlying Causes
The ever rising demands on the exchequer make it all the more crucial for the
government to increase tax revenues by tapping into the potential revenue gap in a
manner that does not penalize economic growth or exacerbate income inequality.
Due to the state of public finances and the economy in general, the need to increase
tax revenue has acquired dimensions that transcend the conventional objectives—
namely, reducing budget deficit and increasing fiscal space for social and
infrastructure development—and has implications on wider issues such as the
exchange rate of the Pakistani rupee, documentation of the informal economy and
governments’ freedom from external players in formulating policy.

III. Recent Developments

The Finance Act, 2016 was by and large a continuation of the government’s
policies in previous years: tax rates were increased, the scope of the withholding
and advance tax regime under the income tax system was broadened to include
further transactions, the differential in rates of income tax collected levied at
source (withholding and advance tax) was increased, conditions for favorable tax
treatment of new industrial undertakings were relaxed and certain exemptions were
withdrawn. In doing so, the majority of commentators argue that the Finance Act,
2016 lacks imagination and failed to introduce measures to tackle the underlying
problems with the tax system in Pakistan.
IV. Looking to the Future
The Federal Government has sought to increase tax revenues by 16 percent in tax
year 2017 and has set a target of 3.6 trillion rupees for that tax year. As of August
2015, the Federal Government was aiming to raise the tax to GDP ratio to 15
percent by tax year 2018. However, given that the tax to GDP ratio as of tax year
2016 stood at 10.5 percent instead of 11.5 percent then targeted, the timeline for
achieving a tax to GDP ratio of 15 percent has been extended to 2020.
Commentators are nearly unanimous that the target cannot be achieved without
substantive and coordinated reforms to document the informal economy and
broaden the tax base. Substantive reforms to the tax system are not expected to be
introduced before the next general elections, which are due to be held in early
2018.