Tuesday, January 11, 2011

Extravagance in the provinces

Extravagance in the provinces

WITH the budgetary deficit becoming unmanageable for the second year running, the focus of policy debate is shifting from federal to provincial fiscal responsibility as a consequence of 18th Constitutional Amendment and 7th National Finance Commission Award.

Many economists warn that the failure of the federal government to rein in provincial extravagance could worsen the macroeconomic imbalances and impact on economic sovereignty.

On the national level, the fundamental structural weakness in the economy remain unaddressed, contributing to rising fiscal deficit that is forecast to cross 7.6 per cent (Rs1285 billion) of GDP this year. The erratic and expensive power supplies have emerged as the biggest challenge for the policy makers resulting in heavy production losses and falling productivity countrywide.

At the end of the last fiscal year on June 30, the country’s consolidated fiscal deficit stood at 6.3 per cent, up 1.1 percentage points over the previous year’s 5.2 per cent. This was 1.4 percentage points higher than the target of 4.9 per cent of GDP set in the budget 2009-10.

The slippage was attributed to higher than targeted expenditure on security and power sector losses at the federal level and non-observance of provincial expenditure ceilings. The provinces did not honour their commitment to provide a surplus savings of about 1.3 per cent of GDP.

At the start of this year, the government set a fiscal deficit limit of four per cent which was revised after devastating floods to 4.7 per cent. This is already reported to have touched 3.5 per cent at the end of first half of the year i.e. December 31.

This year too, there was an understanding given by the provinces that they would provide a surplus of one per cent of GDP to achieve a consolidated deficit of four per cent, revised to 4.7 per cent. As it turned out, the provinces announced deficit budgets.

The general impression among the economic managers is that the provinces have been able to manage the large part of a shift of the consolidated revenue – more than 10 per cent in just one year – than their previous share but are reluctant to take over proportionate responsibilities or absorb employees of the devolved federal ministries. In the process, however, they have raised their own spending without striving for their own revenue mobilisation.

In a sense, the new NFC award has taken away their incentive to generate provincial taxes given the fact they stand to get much higher shares from federal divisible pool without putting in their own efforts.
As a result, independent economists are against irresponsible fiscal stance of provincial governments, who are not part of negotiations with international lending agencies, but could fail the federal government in meeting its international obligations.

With a minor change in the famous comment of American analyst P.J O’Rourke, a World Bank economist Anwar Shah said last week that, “giving money and power to provinces is like giving whiskey and car keys to teenage drivers”. In his view, the provinces or sub-national governments always demand more grants to demonstrate that “they are the champions of wasteful expenditure” because empowered provinces were more likely to undermine even the good local governance.

In his opinion, with the devolution of fiscal and social responsibilities, the provinces were generally expected to be more responsive and having better results because of decision-making going somewhat closer to the people for local transportation and communication networks, better local common markets and reduced intra-regional spill-over and inequalities. However this was possible only if the governments are not run by feudal, industrial and military elites.

This was reinforced by Dr Ehtisham Ahmed, the ministry of finance’s adviser and a central figure advising the government on introduction of RGST. In his view, the 18th Constitutional Amendment and the new National Finance Commission award would collapse in case the government failed to introduce reformed general sales (RGST) as agreed to with the IMF.

He said, the 18th amendment and NFC award had Transferred on paper a lot of resources to the provinces who went on a spending spree on anticipation of increased share, but in reality the revenue collection without RGST was not going to increase and hence their share would remain less than expected and create further fiscal gap. He said the initial transactional cost of fiscal devolution is always high.

Dr Hafiz A Pasha, a seasoned economist and a former adviser on finance, said he never heard of an arrangement where the centre could give 36 per cent share out of its own kitty to the provinces for making them agree on sharing RGST on services where the federation was not going to get anything.
This was not prudent given the fact that the centre was to give away 56 per cent share of the Federal Consolidated Fund to the provinces.

With the fiscal devolution introduced through 18th amendment and NFC award, he said, some structural difficulties have arisen. In his view, the federal government has to give 56 paisa out of every rupee of tax collection, which has eroded its willingness to impose more taxes because the political cost of doing such a thing was too high. Also, because the provinces got higher share out of federal resources, they lacked incentive to raise more revenue.

As a result, according to his conservative estimates, there would be at least three per cent higher fiscal deficit than targeted by the government at 4.7 per cent. He said the problem lay with government’s failure to mobilise revenues, to move forward on the reform agenda and an extravagance showed by the government in increasing salaries by 50 per cent when the country was passing through difficult economic conditions and the impact of floods.

In Dr Pasha’s view, there was a lagged response in development expenditure at the provincial level because of utilisation and absorption capacity. As a result, the share of provincial expenditure could rise from existing 29 to 35 per cent this year.

He said, the original revenue collection target for the current year was estimated at Rs1552 billion but the government announced it at Rs1667 billion, which was a challenging task to begin with.
He said he was concerned over higher provincial expenditures and the fact that fiscal effort was enumerated but there was not much evidence to suggest policy action. As a result, there were significant challenges in introducing new taxes and reforms measures which had not been anticipated and would have medium and long- term serious implications.

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