PAKISTAN Economic Update 3

12. While the external

position significantly improved in the second half of 2008/09, fiscal problems continued and, according to

the provisional data, the fiscal deficit target was exceeded by 0.9 percent of GDP, as the deficit amounted

to 5.2 percent of GDP in 2008/09 (see Table 4). Revenues underperformed as the economy slowed down.

In addition, attempts to control spending to large extent failed.

13. Revenue collection fell short of the target in 2008/09. According to preliminary data, total revenue

collection was 14.2 percent of GDP, which was 1.0 percent of GDP below the revised program target.

The shortfall was primarily due to lower than projected tax collection of FBR, as the economic slowdown

reduced the buoyancy of Pakistan’s two main tax bases (manufacturing and imports). Instead of the

planned increase of 0.4 percent of GDP, revenues dropped sharply by 1.4 percent of GDP to 8.8 percent

of GDP. In the absence of additional tax policy measures introduced during the year, government

compensated the rising shortfall in FBR revenues by increasing the petroleum development levy (PDL)

during the second half of the fiscal year instead of passing on the international price decreases to

consumers. However, even that was not enough to close the revenue gap.

14. Revenues continued underperforming in the first two months of 2009/10. FBR tax collection

during July-August 2009 increased only by 3.6 percent compared to 19.5 percent required to reach the

annual target. While direct and sales taxes grew by 2.9 percent and 9.7 percent, respectively, excise andcustom duties collection contracted by 4.3 and 14 percent, respectively, compared to the corresponding

period last year.

15. In light of the shortfall in revenues, the federal government attempted to reduce the fiscal deficit in

2008/09 by reducing spending, but its attempts were thwarted. First, as power shortages increased, the

government greatly diluted increases in power tariffs for political reasons. As a result, power subsidies

remained high. Second, large overruns in provincial development expenditures compromised federal

efforts. While federal development spending was below the target, provincial development expenditure

exceeded the target. Most of this additional expenditure at the provincial level was financed by

borrowing from the banking system, mainly from the State Bank of Pakistan, with adverse implications

on money supply and inflation.

16. Developments in the first two months of 2009/10 suggest that these worrisome trends continue.

First, continued government inaction on power tariffs implies that electricity subsidies will remain high in

2009/10. Second, the subsidy bill is increasing significantly at the provincial level, as Sindh has followed

Punjab in launching a provincial income support program. In addition, Punjab has doubled its wheat

procurement target, implying a large increase in wheat subsidy. Moreover, large subsidies are allocated

to the provision of wheat and wheat flour to poorer segments of the society at substantially reduced rates.

Similarly, subsidies are being provided both at federal and provincial level for agricultural tractors and

fertilizers. Finally, the federal scheme of providing loans to people for starting small business is also

likely to have a significant impact on the fiscal situation.

17. Since November 2008, Government has met its financing needs mainly through non-bank

borrowing. Consistent with the stabilization program, government’s net borrowing from SBP has been

zero on a quarterly basis. The increase in T-bill placements since mid-November 2008 has enabled

government to reduce the level of monetization and rely on other sources of financing. Borrowing from

scheduled banks was sharply up in 2008/09.