The EFF carries high fiscal risks: IMF

ISLAMABAD: The Expanded Financing Mechanism (EFF) program carries high fiscal risks due to the government’s ability to increase projected revenue from a number of new taxes and the staggered implementation of the Petroleum Development (PDL), the provincial commitment to create a budget surplus and contain current spending in a pre-election year, according to the International Monetary Fund (IMF).

The provincial government of Khyber Pakhtunkhwa has already notified the finance minister of its inability to create a budget surplus due to flooding in the province and other provinces are also unlikely to create a budget surplus due to massive floods.

The Fund, in its latest report “Seventh and Eighth Reviews under the Expanded Arrangement under the Expanded Financial Facility, requests for waivers for non-compliance with performance criteria, and for the extension, increase and rescheduling of access,” said the strategic budget requires timely and decisive implementation of program commitments, but also typically carries very high risks.

The approved budget and the first steps of the LDP and the adjustment of electricity tariffs give a strong signal of the authorities’ determination to implement the agreed commitments. Nevertheless, the budgetary risks for the program are considerable, in particular due to the government’s ability to increase projected revenue from a number of new taxes and the phased implementation of the LDP (with 90% of revenue generated at over the last three quarters), the provincial commitment to deliver the agreed historically high surpluses and the significant containment of current spending relative to GDP in a pre-election year.

The government has committed to the IMF to trigger emergency measures at the first signs of underperformance of the fiscal program, including: (i) an immediate increase in the GST on fuel, as a prelude to reaching the standard rate of 17%; (ii) the continuation of the rationalization of GST exemptions, including on sugar-sweetened beverages (Rs 60 billion) and other unjustified exemptions such as those enjoyed by exporters; and/or (iii) increase federal excise duty on Tier I and Tier II cigarettes by at least Rs 2 per stick with immediate effect to generate at least an additional Rs 120 billion in revenue.

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As soon as monthly data shows signs of underperformance against program revenue targets (for example, if data from a first month in a quarter suggests risks to quarterly performance), the government is committed to activate emergency measures.

The government has also committed to limit spending to 16.9% of GDP, with 0.2% additional spending to clear IPP arrears, and a contingency reserve of 0.25% of GDP has been budgeted for guard against potential shocks. This takes into account the salary and pension increases of 15 and 5%, already granted by the government. It also maintains development spending at FY2022 levels (as a percentage of GDP).

Following the removal of the price gap claim (after-tax fuel subsidy), the government has undertaken to fully pass on changes in international oil prices to consumers. Furthermore, once fuel taxation has returned to its baseline, the government plans to introduce an automatic pricing mechanism.

The provinces have pledged, through Memoranda of Understanding they signed with the Federal Government at the end of July 2022, to meet their individual commitment of an overall provincial surplus of Rs 750 billion. In this regard, quarterly data on provincial budget results will be shared with staff to monitor the implementation of provincial commitments and any likely impact on the federal budget.

The report further notes that risks to the outlook and implementation of the program remain elevated and trending downward given the highly complex internal and external environment. The fallout from the war in Ukraine through high food and fuel prices and tighter global financial conditions will continue to weigh on the Pakistani economy, putting pressure on the exchange rate and external stability. Political slippages remain a risk, as evidenced by FY2022, amplified by weak capacity and strong vested interests, with the timing of elections uncertain given the complex political context.

Socio-political pressures are expected to remain high and could also weigh on the implementation of policies and reforms, especially given the precariousness of the political coalition and their weak majority in Parliament. In addition, high food and fuel prices could cause social protests and instability.

All of this could affect policy decisions and undermine the programme’s fiscal adjustment strategy, undermining macro-financial and external stability and debt sustainability. In addition, high short-term domestic financing needs could overburden the absorptive capacity of the financial sector and disrupt the market.

Copyright Business Recorder, 2022