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November 08, 2018

Institutionalizing Pakistan’s Fiscal Policy Decisions

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Posted by Muhammad Afnan Alam[1]

A dependence on the people is, no doubt, the primary control on the government; but experience has taught mankind the necessity of auxiliary precautions.” (James Madison, 1788)

In a perfect world of fully-informed policymakers solely motivated by social welfare maximization, complete discretion would enable them to optimally respond to changing circumstances at any time. In the real world, however, information asymmetries are pervasive, time-inconsistency looms large, and policy behavior is shaped by considerations other than pure social welfare. Hence, even the best designed democratic systems require institutional constraints on policy discretion to complement democratic controls and prevent undesirable policy outcomes.

The pursuance of a loose fiscal policy by the previous government is partly blamed for the prevalent twin deficits in Pakistan. The fiscal defit of 6.6 percent of GDP in 2018 is much higher than the target of 4.1 percent, and the current account deficit of 5.8 percent of GDP created a balance of payments crisis on the eve of the inuguration of the new government. Such crises are not uncommon in Pakistan. Governments have often been accused of pursuing a fiscal policy based on vague economic assumptions that are politically motivated, with little concern for the long-term impact. The government needs to seriously consider the following four sets of institutional reforms that would enhance fiscal discipline and the transparency of the budget, while removing the excessive discretion that politicians currently enjoy in managing the levers of fiscal policy.

The first institutional reform—which is a low-hanging fruit—would be to develop a new Medium-Term Debt Management Strategy (MTDS). The formulation or extension of this strategy beyond 2018 would send a positive signal to the capital markets, foreign investors and international financial institutions who view the MTDS as critical for providing an accurate picture of the health of public finances. The Ministry of Finance also needs to make progress on implementing the numerical targets that were approved in the amended Fiscal and Debt Limitation Act 2005.

Second, the Ministry of Finance should provide more information to the public on the economic and fiscal assumptions that form the basis of the budgetary process. Rather than being published in undigested form, information on government finances should be accompanied by a fair, balanced and understandable narrative that explains the numbers and relates them to the country’s economic context. This could take the form of explaining data on expenditure, revenue, debt, the deficit and other vital fiscal indicators in terms that the public can easily comprehend.  The reputable Open Budget Index in its 2017 report ranks Pakistan lower than the regional and global average in publishing information on the budget.

Third, the government needs to reconsider the structure of its Medium-Term Budgetary Framework (MTBF). This framework could be accompanied by Public Service Agreements (PSAs) with spending departments and other agencies. Incorporating PSAs through the Budget Act would send a clear message to the public about the services they can expect to receive from the government over the next three years. PSAs, through regular reporting on an annual basis, would provide an unprecedented level of transparency and accountability to the delivery of public services. They would link the resources allocated to spending departments to their performance in delivering the targets set in the PSAs.

Lastly, there is an urgent need to review the role of Pakistan’s Economic Advisory Council (EAC). For the government to put its fiscal policy on track, the country needs to have an institutional framework with a statutory mandate to assess independently the government’s financial plans and the macroeconomic assumptions that feed into the budget. Independent Fiscal Councils (IFCs) are recognized by the IMF and other bodies as an integral part of a robust public financial management system. Some 37 countries have already established an IFC, which have assisted the government in delivering more transparent budgets and objectively-based and robust fiscal policies. Interestingly, many of these IFCs were created in similar economic conditions to those that Pakistan is currently experiencing.

For instance, the British Government, through an Act of Parliament established the Office of Budget Responsibility (OBR) in 2010 after the British Treasury office reported ballooning public debt and a substantial budgetary deficit. The OBR’s reports are considered to provide independent and authoritative macroeconomic forecasts as well as analysis of the UK’s public finances, and 5-year economic and fiscal forecasts. The methodology and assumptions adopted by the OBR are published. The UK government, with the assistance of the OBR, was able to take steps to restore fiscal sustainability through entitlement reforms and revenue measures.

The United States’ IFC, known as Congressional Budget Office (CBO), provides the Congress with independent analyses of the costs and long-term effects of budget proposals. The CBO produces many reports each year and regularly testifies before Congress. The Office has developed a reputation for providing credible and impartial analyses that has helped it become a central player in the annual budget process and budget monitoring.  The Netherlands’ Central Planning Bureau (CPB) is another IFC that is free from political interference and has established a credible record of impartial economic and fiscal analysis and reporting.  

Pakistan’s efforts to institutionalise the decision-making process on fiscal policy will be a first step to ensure the long-term sustainability of the public finances. They would also assist in strengthening fiscal transparency and support the government’s objective of improving the delivery of key public services.

[1] The author is a civil servant and holds an MPA from the London School of Economics and Political Science (afnanalam@gmail.com).

Note: The posts on the IMF PFM Blog should not be reported as representing the views of the IMF. The views expressed are those of the authors and do not necessarily represent those of the IMF or IMF policy.

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